Treasuries Still Standing After CPI and Fresh Supply
Treasuries Still Standing After CPI and New Supply
The Treasury market rather easily absorbed hotter-than-expected CPI and PPI reports, not to mention new 3yr, 10yr, and 30yr supply. So that begs the question, if a red-hot CPI and fresh supply can’t move yields over recent highs what will it take? Maybe today’s retail sales report, but that’s expected to be a rather tame print after March’s stimulus check-induced spending splurge. The Treasury market could be reading the latest price spikes as more transitory, just like the Fed has been on about for the last couple months. What could change that reaction? Well, wage increases announced by the likes of McDonald’s, Amazon and Chipotle are a start, but for now the market is treating them with a collective shrug. If more companies follow suit, however, will that continue to be the reaction? We try to answer that question in the last section below. Finally, we want to remind everyone of our latest podcast. Earlier this week, I sat down with Joe Keating, Co-Chief Investment Officer, NBCS Asset Management to discuss his latest thoughts on the economy, inflation, rates, and stocks. The iTunes link can be found here and the Spotify here.
Price Spikes in a Few Categories Led CPI Higher
April CPI and PPI came in hotter-than-expected and now the debate begins as to how much was due to the much talked about base effects and pandemic induced supply-constraints. Every Fed official speaking after the lofty CPI print didn’t alter the message that they are looking past this spike in prices as being transitory in nature. And they do have plenty to hang their hats on in that regard. The bar chart below illustrates that much of the increases in CPI came from used cars and trucks and other reopening categories. The 10% jump in used cars was particularly noteworthy as it came, at least partially, as a consequence of chip shortages for new cars just as rental car companies were forced to meet surging demand with used car purchases.
In fact, two-thirds of the 0.8% monthly increase in overall CPI came from the combined used car/truck and other reopening categories. Airline fares, hotels, and restaurant/bars all saw large upswings as well that reflect a reopening economy and expected surge in demand. The Fed no doubt noted that price action as almost the textbook definition of transitory price moves. And it has to be said that while Treasury yields backed up off the hotter-than-expected numbers, the 10-year yield could only get to 1.69%, well shy of the 1.74% high set back on March 31. So one has to ask, if that CPI report couldn’t get yields to challenge the recent highs what will it take? Perhaps more evidence that the price increases will be more durable? In that regard we are starting to see wage increases from notable employers: McDonald’s, Amazon and Chipotle to name a few, so the inflation story is far from over. In fact, it’s likely to be THE driver of price and yield action as we move through the balance of this year. Stay tuned.
A Hot CPI Report is Still Playing Catch-Up
A little more perspective on the April CPI report as we often get caught up in the minutiae of a single month’s numbers be it CPI or jobs reports. Certainly, this month had a hodge-podge of forces that colored the report in a glowing red hue. From large negative prints from last year rolling off the calculations, to surges in demand from reopening sectors of the economy, to chip shortages driving used car prices higher, the noise in this report was enough to nearly drown out the signal.
Barron’s looked at it another way. They went back to 2018 and tracked where the CPI Index could have reasonably been under various scenarios. As the graph shows, if the Fed had being using its new average inflation targeting framework back in 2018 the index could have been nearly 110.0 absent the pandemic. Using the Fed’s previous 2% inflation target approach the index could have risen to just over 107.5. The latest CPI reading was, in fact, just under 107.5. They also included the core rate less the recent volatile sectors which reached 105.0. That may represent a bit of cherry-picking but the larger point is that price levels today are just now returning to the levels we would have expected without the pandemic-induced interruption. Just some points of debate when confronting the hyperinflation, cryptocurrency crowd at your next cocktail party.
More Wage Gains Needed for More Durable Inflation
We wrote earlier about the Fed largely looking past the spikes in the April CPI numbers while also looking for increasing wage gains to signal a source for a more durable increase in inflation. Much like everything else, the pandemic has clouded the signal from Average Hourly Earnings numbers. The graph below shows YoY prints for production/non-supervisory workers. We use this metric for two reasons: the data goes back to 1960 and these are the workers most likely to be coming on board in the last phases of economic reopening. Spikes in the early months of reopening probably reflect more factory/production line personnel returning while the latest month (1.2%), reflects more the lower-wage, services-side workers returning and pulling the average earnings lower. Away from the hubbub of base effects and supply bottlenecks, the Fed will want to see these earnings settle into a nice upward trend, perhaps approaching the 4.2% YoY average, before engaging in serious policy tightening. That will take some time which is just another reason to expect the Fed to remain patient in the face of coming calls they are falling behind the inflation curve.
|Treasury Curve||Today||Chg Last Wk.||LIBOR Rates||Today||Chg Last Wk.||FF/Prime||Rate||Swap Rates||Rate|
|3 Month||0.00%||-0.01%||1 Mo LIBOR||0.10%||-0.01%||FF Target Rate||0.00%-0.25%||3 Year||0.442%|
|6 Month||0.02%||-0.01%||3 Mo LIBOR||0.15%||-0.04%||Prime Rate||3.25%||5 Year||0.891%|
|2 Year||0.15%||-0.01%||6 Mo LIBOR||0.19%||-0.01%||IOER||0.10%||10 Year||1.592%|
|10 Year||1.64%||+0.06%||12 Mo LIBOR||0.26%||-0.02%||SOFR||0.01%|
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