What 76% of Traders Are Nearly Certain Of. Until Tomorrow, At Least.

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The graph above (courtesy of the Cleveland Federal Reserve) shows why mortgage have trended higher over the last 30 days. 

The blue line labeled 5.250% represents the current Fed Funds Rate.  As we move farther to the right, the line changes to reflect the where traders believe the FFR will be after the Fed's May meeting.

More importantly, each line represents inflation expectations in the markets.  The FFR does not control mortgage rates because it is the ultimate short-term interest rate versus the 30-year pricing model of mortgage bonds, but inflation is impacting them both right now. 

If the Fed attempts to slow down the economy by raising the FFR, it will also cause mortgage rates to increase because the future value of the dollar will be expected to erode.  Traders, therefore, will demand a premium to buy bonds priced in U.S. Dollars.  "Premium" = "higher yields on bonds" = higher mortgage rates for homeowners.

If that doesn't make sense, just ask yourself: Would you want to hold an asset whose value is deteriorating?  I'll answer for you.  No, you wouldn't.  Unless somebody paid you extra to compensate for the added risk.

So, now we can see how inflation expectations relate Fed's next move to mortgage rates.  If the Fed sees the risk of inflation, it will raise the FFR and that signals a devaluing of the currency which leads to more risk for investors.

Because the chart shows a trailing 30 days, we can see the change in expectation from mid-December, though the strong housing numbers released in late-December, through the unexpectedly strong jobs report two weeks ago, and finally, leading up to today's CPI and housing reports.

Because both figures surprised higher, we can expect the probability of a 5.250% FFR in May to increase, sustaining the upward pressure on rates.