The Consumer Price Index (CPI), which measures inflation on the consumer level, showed that inflation decreased by 0.1% in December. On an annual basis, inflation declined from 7.1% to 6.5%. Core CPI, which strips out volatile food and energy prices, rose 0.3%. As a result, year-over-year Core CPI decreased from 6% to 5.7%. All of these figures were in line with estimates.

Of particular note, shelter costs make up 39% of Core CPI and they rose 0.8% in December, meaning they played a big role in the 0.3% monthly gain in Core CPI. However, shelter costs have been lagging in the CPI report, as they have been coming down in more real-time data. Once these moderating shelter costs are reflected in the CPI data, they should add additional downside pressure to inflation. 

What’s the bottom line? Inflation is the arch enemy of fixed investments like Mortgage Bonds because it erodes the buying power of a Bond's fixed rate of return. If inflation is rising, investors demand a rate of return to combat the faster pace of erosion due to inflation, causing interest rates to rise as they did throughout much of last year.

Since lower inflation typically helps both Mortgage Bonds and mortgage rates improve, these signs of easing inflation are welcome. In fact, if you took the last three monthly CPI readings and averaged them over the next 12 months, the run rate would be 1.6%. Doing the same for Core CPI would give us a run rate of 3.2%. If the lower monthly readings we’ve seen recently continue, they will help us make substantial progress towards the Fed’s 2% inflation target.