The U.S. economy isn’t responding to higher interest rates the way central bankers expected, and mortgages could be to blame, according to the Fed.

During a panel discussion in Amsterdam, Fed chair Jerome Powell said the economy is “different this time” because so many homeowners refinanced their mortgages at lower rates during Covid.

But it's not just mortgages. Large corporations also locked in lower rates through a record volume of bond issuances when interest rates were at rock bottom.

Powell said a higher rate is “hitting the economy not quite as strongly as it would have if those two things were not the case.”

While higher interest rates have dissuaded Americans from purchasing new homes, they’ve had a minimal impact on existing mortgage holders.

According to Creditnews Research, more than 40% of all U.S. mortgages were obtained in 2020 or 2021 with an average 30-year mortgage rate of less than 4%

If the economy really is different this time, the Fed has no choice but to keep rates higher for longer to bring inflation back down to target.

That was Powell’s key message earlier this week when he admitted that recent inflation reports “were higher than I think anybody expected" and urged patience.

Inflation data: A mixed bag

The most recent batch of inflation readings has provided mixed signals about where prices are headed.

On the one hand, the Producer Price Index (PPI), which measures inflation at the manufacturing and wholesale levels, rose in April at the fastest annual pace in a year.

That usually foreshadows higher headline inflation in the future as producers pass on rising costs to consumers.

But the silver lining came one day later when government data showed a slowdown in consumer prices during the same month.

The Consumer Price Index (CPI) rose 0.3% in April, ending a streak of three consecutive months of higher-than-expected readings.

The all-important Core CPI, which strips away volatile goods such as food and energy, posted its smallest year-over-year increase since 2021.

Economists took the CPI report as a positive sign that the U.S. wasn’t about to enter another inflationary spiral.

“The country is not out of the woods from the threat of inflation, but we can start to see the end of the forest,” said Christopher Rupkey, chief economist at FWDBONDS.

“It does open the door to a potential rate cut later in the year,” said Charles Schwab’s chief fixed-income strategist Kathy Jones. “It will take a few more readings indicating that inflation is coming down for the Fed to act.”

According to Bloomberg Economics’ Anna Wong, Stuart Paul and Estelle Ou, “April’s CPI should keep the chances of a July rate cut alive, for now.”

However, the economists warned that Fed officials are “likely still less confident than they were entering 2024.”

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