For anyone wondering why we had such large fluctuations in the mortgage market last week, following is a great recap of the industry as originally distributed by Shane Price with Houston Capital Mortgage.

Last week's economic news proves that it can be tortuously difficult to turn lemons into lemonade, especially when there is no sugar to be found.

To wit, housing starts slipped another 3.3% to an annual pace of 975,000 units in May, the lowest level in 17 years.

That news alone isn't necessarily bad; fewer homes are being added to an already bloated inventory.

But when builders were asked for their view of the current market – number of buyers looking at homes and expectations for six months from now – only 5% believed the current market is favorable, down from 6% in May.

The producer price index further dampened spirits. The PPI surged 1.4% in May, seven times the increase we saw a month earlier and greater than the 1.2% rise many economists were predicting.

Wholesale inflation is now running at a 7.2% year-over-year rate, just shy of a multi-decade high. As for “core” inflation (which excludes food and energy costs and one-off surges in prices due to regional droughts, hurricane strikes and other short-term events), it's now rising at a 3% year-over-year rate, the fastest since 1991.

The relationship between inflation and interest rates is positive and causative.

With inflation indicators rising, it's no surprise that mortgage rates would rise as well.

And they just did. Rates were up for the fourth consecutive week, having increased half a percentage point in the latest week.

The prime 30-year fixed-rate mortgage rose to 6.62%, the prime 15-year fixed-rate mortgage rose to 6.20%, while the 5/1 adjustable-rate mortgage rose to 6.24%.

Rates are the highest they've been this year and are approaching levels not seen in a year.

UP, DOWN OR NEUTRAL?

All eyes will be focused on the Federal Reserve this week.

The consensus estimate calls for the Fed to hold the fed funds rate at 2% this week, but to eventually raise it by the end of September.

Regardless, rates have already risen on the 10-year Treasury note, which strongly influences mortgage rates

The bad news for the Fed (and for the rest of us) is that inflation is rising while the economy is slowing.

If the Fed cuts rates to stimulate the economy, the inflation fires will be stoked and an already eroded U.S. dollar will be further eroded.

If the Fed raises rates, however, the flames will be doused, but that's of little comfort to an economy sliding toward recession.

At this point, inflation probably trumps recession, suggesting a rate increase is in order.

At least an increase would signal that the Fed is serious about fighting inflation.

At a minimum, the Fed should assure credit markets that it stands vigilant. A little fear-assuaging on the Fed's part this week could possibly reverse the recent rate-increase trend.