While food and energy prices have been rising globally, overall inflation levels have generally stayed low. The big monthly US inflation reports released this week revealed that core inflation remained low in January, but that it has moved higher over recent months. January CPI was a tame 1.6% higher than one year ago. Core CPI, which excludes food and energy, was only 1.0% higher than one year ago. During the week, we also received an early sign that inflation may be higher down the road. The Prices Paid component of the Philly Fed index jumped sharply, reflecting that raw material costs rose. The question is whether companies will be able to pass along higher costs to consumers.

The FOMC Minutes from the January 26 Fed meeting were released on Wednesday and contained no major surprises. The minutes revealed that disagreement was growing among Fed officials about the benefits of continuing the quantitative easing program which is scheduled to end in June. However, there was general agreement that the hurdle for altering the program remains very high, and investors continue to expect the Fed to complete the $600 billion in purchases of Treasury securities as originally planned. The Fed raised its forecast for 2011 GDP growth to 3.65% from their prior estimate of 3.30% in November. Perhaps the biggest surprise was that the Fed lowered its forecast for 2011 core PCE inflation levels. With all the recent evidence of rising prices, lower inflation predictions were not expected.

Over recent months, Texas mortgage rates have moved higher due to investor concerns that future inflation will rise significantly. Inflation can come from different sources. A desirable source is inflation which results from stronger economic growth, which leads to more jobs and higher demand for goods. On the other hand, inflation which results from large budget deficits comes with very few benefits. Both are pressuring Texas mortgage rates higher right now, but at least with an improving economy more people are able to buy homes.

On Friday, the Treasury released its recommendations for reforming Fannie Mae and Freddie Mac. According to Treasury Secretary Geithner, this report is a starting point for a national debate. The central question is what role the government should have in the mortgage market. Geithner stressed that changes will take place very gradually over a period of years to avoid disruptions to the housing market.

Global economic growth has been picking up, particularly in developing countries, which has increased the demand for commodities. Many developing countries already have had to deal with rising inflation, and readings in Europe have moved higher recently as well. In the US, Fed officials tend to focus on core inflation (which excludes food and energy), and these measures have been extremely low. According to Bernanke, slow wage growth and slack in the US economy will help keep core inflation in the US low for quite a while. This has allowed Fed officials to keep monetary policy loose to boost the economy. Investors, though, have grown more concerned about the risk that the Fed’s stimulative policies will lead to significantly higher long-term inflation.

While the headline number fell short, this week’s Employment report was considered to be positive overall, and Texas mortgage rates moved higher after the news. Against a consensus forecast of 140K, the economy added just 36K jobs in January. The Unemployment Rate was expected to increase to 9.5% from 9.4% in December. Instead, it dropped to 9.0%, the lowest level since April 2009. Economists suggest that a number of factors were responsible for the divergence between the two sets of data. First, bad weather distorted the results in many regions. Second, the Unemployment Rate reflects both smaller companies and larger companies, while the payrolls data captures only larger companies. Finally, the January data tends to be the least reliable month of the year. After examining the details, investors placed more weight on the growth in jobs among the small businesses and self-employed, and they expect the payrolls data to “catch up” in future months.

Inflation is always negative for bonds, since it erodes their value over time. Despite improving economic growth, there have been few signs of rising inflation in the current environment, which has helped keep mortgage rates at low levels. The December Consumer Price Index (CPI), the most closely watched inflation indicator, was just 1.5% higher than one year ago. Core CPI, which excludes the volatile food and energy components, increased an even lower 0.8% from one year ago. While food and energy prices recently have been rising more rapidly than the overall price level, investors generally focus on core inflation. The Fed considers a range for core inflation between 1.5% and 2.0% to be most desirable for the long term.

A second important influence for mortgage rates is the level of investor demand for bonds. If demand falls, then yields must rise to attract additional investors. A good indicator of investor demand for bonds comes from the Treasury auctions. During the week, demand was stronger than average from both domestic and foreign investors for longer-term 10-year and 30-year Treasury securities. Since mortgage-backed securities (MBS) and longer-term Treasury securities are similar investments, mortgage rates generally benefit from strong Treasury auctions, as was seen this week.

After reaching record lows in early November, mortgage rates have since increased, although they remain at historically low levels. The rise in mortgage rates can be attributed primarily to a good thing, increasing expectations for future economic growth. The trend in most economic measures over the last few months has generally shown improvement, and the passage of the tax deal last week is expected to provide an additional boost. A growing economy creates jobs and increases the demand for homes, but it also leads to higher inflation, which is negative for Austin mortgage rates.

The housing sector data released during the week was positive. November Existing Home Sales rose 6% from October, and inventories of unsold existing homes fell 4% to a 9.5-month supply. November New Home Sales also increased 6% from October.

In short, when investors look ahead, they see few reasons for Texas mortgage rates to move lower and many possible causes for them to move higher. The major negatives for Austin mortgage rates include stronger than expected economic growth, domestic and foreign opposition to quantitative easing, and concerns about lower foreign demand for US securities.

Beginning in late August, the Fed hinted that they would initiate a new stimulus program to purchase Treasury securities, which is known as quantitative easing. In the short-term, Treasury buying by the Fed increases demand for bonds, including mortgage-backed securities (MBS). In anticipation of this added demand, investors purchased MBS, which pushed Texas mortgage rates lower.

After the Fed’s official announcement on November 3, Texas mortgage rates began to move higher for a variety of reasons. Stronger than expected economic data caused investors to raise their outlook for economic growth, which generally leads to higher inflation. In addition, there was substantial opposition to the quantitative easing program from other countries and from many US politicians and economists, meaning that the Fed will face strong resistance to an expansion of the program. Investors had viewed the $600 billion initial level as a first step which would likely be increased in the future. Stronger economic growth and opposition to quantitative easing has reduced the likelihood that the program will be increased.

The recent news has not been uniformly negative for mortgage rates. Current inflation levels remain extremely low. In fact, the Consumer Price Index data released this week showed that annual core inflation dropped to a record low in October. Bottom line, though, when mortgage rates reached such extremely low levels, it left them in a position to reverse direction very quickly.

In an effort to boost the economy, the Fed is expected to begin to purchase additional Treasury securities soon. The big question is how large the program will be. Investors expect the Fed to reveal the details of the program at its next FOMC meeting on November 3. Comments from Fed officials during the week indicated that they are still discussing what approach to take. The Fed may decide on a fixed quantity over a set time frame, or they may select a more flexible program in which they decide at each meeting how much to purchase. Austin mortgage rates have already benefitted from investor expectations for the program, and they likely will remain highly sensitive to changes in the outlook for the Fed’s plans.

While foreclosure issues were in the spotlight, this week’s housing sector data generally showed modest improvement. September Housing Starts increased to the highest level since April. The October NAHB Home Builder confidence index rose to 16 from 13 in September, which was the first increase in five months. “Builders are starting to see some flickers of interest among potential buyers,” according to the NAHB.

A speech by Fed Chief Bernanke on Friday confirmed the expectation that the Fed will soon provide additional monetary stimulus by purchasing Treasury securities. The Fed’s plan is to boost the economy and to bring the inflation level up to the Fed’s preferred rate. According to Bernanke, “There would appear – all else being equal – to be a case for further action.” Investors hoping for more information about the size of the purchase program were disappointed, as Bernanke stated that it is still being discussed by Fed officials. Investors expect the Fed to reveal the details of the program at the next FOMC meeting on November 3, if not sooner.

The data released during the week showed that core inflation remains below the Fed’s desired range of 1.5% to 2.0% per year. The September Core Consumer Price Index (CPI), which excludes the volatile food and energy components, increased just 0.8% from one year ago, which was the lowest annual rate in more than 49 years. Central bankers around the world generally agree that a stable, positive inflation rate is optimal for long-term economic growth.

While the private sector performed relatively well, Friday’s Employment data revealed net job losses and stagnant wage growth in September. Against a consensus forecast for a loss of 5K jobs, the economy lost 95K jobs. The weakness was seen mostly in the government sector, as state and local governments continued to shed jobs. The private sector actually added 64K, which was close to expectations. The Unemployment Rate remained at 9.6%. A broader measure, which also includes the underemployed, rose from 16.7% in August to 17.1%, matching the high reached in April. Average Hourly Earnings, a proxy for wage growth, was unchanged from August.

The Fed’s recent announcement that it may purchase additional Treasury securities (quantitative easing) to stimulate the economy has magnified the importance of economic news and increased daily volatility. Investors now evaluate each fresh piece of data in terms of its expected impact on Fed policy, and mortgage rates receive an extra benefit from weaker than expected data. In general, weaker economic growth leads to lower future inflation, which is favorable for mortgage rates. In addition, investors now expect higher levels of bond purchases by the Fed after weak data, and the increased demand also would be positive for mortgage rates. Of course, stronger than expected economic news will have the opposite effect and will push rates higher more quickly than usual.

During the week, a series of Fed officials shared differing viewpoints on the possibility of additional Fed purchases of Treasury securities. While the officials are divided about both the need and the effectiveness of buying bonds to stimulate the economy, the majority view appears to be that the Fed should undertake this action unless the pace of the economic recovery improves soon. A flexible program to purchase smaller quantities of Treasury securities has emerged as an appealing middle ground for Fed officials.

Overall, a new Treasury purchase program would be favorable for Austin mortgage rates. Increased Fed demand for Treasury securities would also increase demand for similar investments including mortgage-backed securities (MBS), which would push Austin mortgage rates lower. Investors have already priced in the likelihood that more purchases will take place. There may be a downside, though. In contrast to the recent MBS purchase program, which involved a relatively steady, well defined level of weekly buying, the new program may be geared to allow the Fed to adjust its purchases based on changing economic conditions. By its nature, a program that is more flexible will be less predictable. The uncertainty will likely lead to increased volatility for Austin mortgage rates, as investors amplify their reaction to each piece of economic news.