Inflation Eases

Mortgage markets were pulled in different directions this week. Increased tensions in the Middle East caused oil prices to climb, raising concerns about the outlook for future inflation. On the other hand, consumer spending slowed, and certain inflation measures came in softer than expected. While these offsetting influences created some market volatility, mortgage rates finished the week with little overall change.

To reduce short-term volatility and get a clearer picture of underlying inflation trends, investors look at core CPI, which excludes food and energy. In July, Core CPI was 2.5% higher than a year ago, also down from last month. Shelter (housing) costs were up 3.2% on an annual basis and continue to be a primary reason why bringing inflation down to the 2% target of the Fed remains challenging. Airline fares, medical care, and used vehicle prices also posted significant increases this month.

A different inflation report released this week, which measures wholesale costs for producers, contained positive news for mortgage markets. The July Producer Price Index (PPI) was 4.7% higher than a year ago, down from 5.5% the prior month and far below the consensus forecast. Investors generally tend to place more weight each month on the Consumer Price Index report, which better reflects overall inflation levels in the economy. However, the surprisingly soft PPI reading gave mortgage markets a bigger boost than usual.

Consumer spending also showed signs of moderating. After the temporary boost from larger than usual tax refunds faded, retail sales in July unexpectedly dropped 0.6% from June, far worse than the consensus forecast for a slight increase and the weakest monthly reading since May 2025. Spending continued to be driven by higher-income households, supported by continued strength in the stock market. Of note, nonstore retailers posted a large decline this month, likely in part because Amazon Prime Day took place in June this year instead of July.

The big picture: Inflation appears to be gradually cooling, while the economy continues to show resilience. Investors will be watching that balance closely for clues about the Federal Reserve's next moves and what those moves could mean for mortgage rates in the months ahead.

Looking ahead, attention will remain fixed on the conflict in the Middle East and the proposed deal to ease tensions. Investors also will monitor comments from Fed officials about future monetary policy. The detailed minutes from the July 29 Fed meeting will come out on Wednesday. It will be a light week for economic data. Housing Starts and Import Prices will come out on Tuesday.