For the past few months, inflation was the spectre economists and analysts mentioned when discussing news of government stimulus and continuing low rates. People were wondering why, for all this money being poured into the economy, inflation still seemed to be hanging around below the Federal Reserve’s 2% target rate. This week, that spectre materialized in the form of a 4%+ inflation rate reflecting the rising costs of a range of goods, from household essentials to used cars.

The sudden onset of inflation comes as a difficult time for the mortgage industry, as rising rates and competition have already seen major lenders cut into their margins. To find out why we’re seeing inflation now and what that could mean for originators and the rates they sell on, MPA spoke with Fannie Mae’s chief economist Doug Duncan (pictured), who explained that this spike in inflation didn’t come out of the blue. Rather, it’s the product of a range of factors being weighed by bond markets.

“The bond market had to sort through whether there was more than one vaccine implemented, whether they would be distributed rapidly, would they be impactful, would they be resilient to new strains of the virus, how consumers, policymakers and businesses respond to that,” Duncan said. “You also have a new administration putting new regulatory leaders in place, raising the question of how that would impact financial markets. There’s also a proposed $1.9 trillion of additional stimulus and questions around how quickly that would seep into economic activity…The market was weighing all these decisions to form an expectation of where rates were going to go and as it started to reach a conclusion, that created momentum in one direction and that’s where rates went. Now the question is how much of that change in rates is an inflation expectation versus a growth expectation?”

Duncan noted that what we are likely seeing is a combination of inflation and growth expectations on the bond market, which will likely force rates higher as they account for both real growth and inflation. Added into this mix, though, are a host of supply-chain issues which are up against a huge bounceback in consumer demand. Duncan cited the current shortage in car microchips as a prime example of how supply chain issues are raising prices. As monetary stimulus puts more and more pressure on the demand side and the supply side looks somewhat stagnant, the risk of inflation grows higher and higher.

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If the bond market has the right idea, Duncan explained, then we should expect the 10-year treasury to rise again which will result in rising mortgage rates. That rise ought to result in even deeper cuts to mortgage companies’ margins as well as downsizing or outright “firm departures,” according to Duncan. Whether companies close altogether or simply lay off staff, Duncan expects the industry’s overall capacity to shrink.

Even if rates are rising in the face of inflation, Duncan noted that the Fed is unlikely to pile on by raising their key interest rates. Messaging from the Fed so far is that they’re willing to let inflation run while the economy and job market are still recovering and while the rate and timeframe have been left vague, Duncan expects that Fed chairman Jerome Powell won’t add on to the rising rate environment.

As mortgage professionals stare down the barrel of a rising rate environment, Duncan believes they need to return to the fundamentals. Refis will be the first thing to dry up and mortgage pros need to look at their purchase relationships and referral relationships to weather any coming storm.

“My view is that if you’re in the mortgage industry, you are in the business of making mortgages for people who want to buy houses,” Duncan said. “The refinance stuff is gravy that is simply presented as an optionality to households. Today, the bias should be towards planning for higher rates. I would be watching inflation indicators very carefully and listening to what the Fed is saying to see if there’s any weakening in their position about changing policy…I would position myself to be more efficient in my operations on the purchase side.”