How Rising Inflation and Mortgage Rates Could Affect the Stock Market

It often seems things like economic conditions and financial markets are somewhat esoteric. There is a tendency among market insiders and commentators to get lost in the minutiae of data and chart analysis, making even important subjects seem boring and irrelevant. That can be true in terms of the relative performance of individual stocks, and certainly is when it comes to subjects like bond market analysis. But economic conditions affect us all, and we are reminded of that on days like this, when two important numbers are in focus, the average mortgage rate, and the Consumer Price index (CPI), or inflation rate.

The news for the average American is not good on either front. Combined, they point to a possible drop in house prices that would have a ripple effect throughout the economy and ultimately cause a drop in the stock market.

The average 30- year fixed-rate, conventional mortgage in the country climbed back above the psychologically important 5% level this morning, a level that was breached last week before dropping back just a little then rebounding.

Mortgage rates

As the above long-term chart from the St. Louis Fed shows, that is still low in an historical context, but people don’t make home purchasing decisions based on where rates were twenty or thirty years ago. More relevant to those decisions is that the current level is almost double what was available to borrowers at the end of last year. For most people, what matters when they buy a house is not really the nominal price of the property, but rather the monthly mortgage payment that they will take on if they do. So, as rates rise, every house on the market becomes more expensive for potential buyers, even if the price stays the same.

It’s fair to assume that mortgage rates will continue to climb given that the Fed indicated it intends to keep pushing short-term rates higher for at least the rest of this year. The big jump in house prices that we have seen over the last few years is coming to an end. We may even shift into reverse, with average house prices actually falling later this year. That is made even more likely by the fact that inflation is at thirty- or forty-year highs.

This morning’s data showed that the annual increase in consumer prices is rising at 8.5%, slightly higher than the forecast of 8.4%. Potential homeowners will therefore have less money left after food, energy, and other bills to allocate to a mortgage, which is already becoming more expensive as rates rise. In those circumstances, a substantial drop in house prices is definitely on the cards.

In some ways, that is not all bad news. Studies have shown in the past that people’s perception of their personal finances are tied to property values, so as house prices adjust, consumer demand is likely to fall with them. That will accelerate and exaggerate the dampening effect of the Fed’s rate hikes and may even lead to fewer rate rises this year than currently anticipated.

Still, the fact is that higher mortgage rates and high inflation will impact housing prices in a way that will have a negative impact on everyone who owns their house and, in America, the homeownership rate is 64.8% . That is a large number of households that are going to feel significantly poorer as this year wears on. It could mean that spending on everything will fall, including a decrease in the money allocated to investments. Individual investments aren’t a huge part of overall stock market activity, but any loss of buyers in an already thin, volatile market is a worry.

This morning’s news is “news you can use” in the sense that it is relevant to even casual investors, but it isn’t good. Rising mortgage rates and high inflation combine to make a drop in house prices very likely this year, and that will have an impact on everything, including the stock market.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

Jinggo B Danuarta

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