Fund managers were polled by Bank of America recently and they now see inflation, a taper tantrum, and higher taxes as bigger risks than COVID-19. That poll came before the Johnson & Johnson vaccine news so don’t write-off the virus just yet but the trend is definitely in that direction. As for inflation, we got a look at March CPI yesterday and while stronger than expected, the market reaction was muted. All the Fed jawboning over not to worry about the report appears to have paid off for now. Expect the same for the April report which is likely to post another temporary spike in prices. We discuss the report in more detail below.  Finally, in our latest podcast we sit down with Bert Purdy from BKD to discuss all things strategic planning and how to increase engagement via LinkedIn.  The iTunes link can be found here and the Spotify link here.


Economic News

The March CPI report was stronger than expected but is not likely to alter the Fed’s inflation outlook and the Treasury market took the report largely in stride. With Fed officials warning for weeks that the March report would be strong, the market got the message that while the increases are significant, they will likely be temporary due to supply bottlenecks and more importantly math. The March report is the first to reflect Base Effects from last year’s plunge in prices that occurred during March and April as shutdowns rolled across the economy. For example, March of 2020 saw a monthly CPI reading of –0.3% and that rolled off the calculation in this report. Next month it should be even worse when April 2020’s –0.7% print gets excluded from the year-over-year numbers.



For March, headline CPI rose 0.6% versus 0.5% consensus and 0.4% in February.  The gain was the biggest increase since August 2012 and was driven primarily by higher gas prices. The headline year-over-year rose to 2.6% from 1.7% and just above the 2.5% consensus. The yearly gain was the largest since August 2018.  Thus, you can see the impact of the March 2020 negative print rolling off the calculation and the solid 0.6% being added on. The core CPI rate (ex-food and energy) rose 0.3% in March versus 0.2% consensus and 0.1% in February. The core year-over-year rate rose to 1.6% versus 1.5% consensus and 1.3% in February. As we mentioned, the April report will show another boost to those numbers but we’re likely to continue to get Fed messaging to not be alarmed at these temporary moves. The Treasury market seems to have bought the Fed’s jawboning for now as price action was muted with gains coming late in the day for most maturities.

Inflation Breakeven Rates Remain Stubbornly High

While the Fed may have done a good job convincing investors not to worry about the next couple inflation reports, the TIPs market, at least, still thinks there will be a decent amount of inflation given where the TIPS Breakeven Inflation Rates currently reside. Recall that Treasury Inflation Protected Securities (TIPS) are Treasury securities that pay a small coupon plus additional compensation tied to the CPI. In the market pricing of TIPS one can tease out the level of expected inflation. In the graph below you can see both the five-year TIPS inflation breakeven rate (blue line) and the ten-year TIPS inflation breakeven rate (white line). As shown, both rates are well over 2.00% but have held recently at current levels.


While the grind higher since the low readings reached last March has been quite impressive, expecting inflation of 2.61% over five years and 2.34% over ten years is not exactly an inflation scare. Given the Fed’s new policy framework in allowing inflation to average 2.0% over time, after spending years under 2.0% the Fed appears ok if it moves into the TIPS projected ranges for a few years. That’s one reason you haven’t heard much concern over the recent increase in nominal Treasury yields as they have, for the most part,  followed the breakeven rates higher. Now, if the breakeven rates start to move upward again towards 3%, or higher, then you will probably see a little more concern on the part of the Fed, but for now they are pretty comfortable at the outlook. Temporary, supply-driven price hikes won’t concern the Fed. What will concern them is rapidly rising wages that spur demand-driven inflation that is the more long-lasting creating durable price hikes. To date, we haven’t seen that pattern so again another reason for the Fed to look on comfortably for the time being.

Agency Indications — FNMA / FHLMC Callable Rates

Maturity (yrs) 2 Year 3 Year 4 Year 5 Year 10 Year 15 Year
0.25 0.12 0.37 0.70 1.08 2.11 2.57
0.50 0.11 0.34 0.64 0.97 1.97 2.46
1.00 010 0.31 0.61 0.93 1.88 2.33
2.00 0.30 0.55 0.85 1.76 NA
3.00 0.80 1.70 NA
4.00 1.65 NA
5.00 1.61 NA
10.00 NA

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Published: 04/14/21 Author: Thomas R. Fitzgerald