When Is Hot Not So Hot?

A hotter-than-expected May CPI came and went and Treasuries sold off, right? Well, no. After a little early knee-jerk selling, buyers quickly came to the fore and Treasuries ended the day with lower yields, even in the face of new 30-year bond supply. What’s going on, you say? Well, it’s that “transitory” term again and digging into the report it’s clear a few categories, with very specific stories, accounted for the bulk of gains that will likely pass as pent-up demand gets satisfied. The big culprit for the month was again used cars which saw an increase of more than 7% (fully one-third of the monthly increase) and this comes on the heels of a 10% increase in April. The story of the used car saga is pretty well-worn by now but as micro-chip shortages stalled new car production, rental car companies, with consumers returning to traveling in a big way this spring and summer, headed to the used car lot to buy vehicles for fleets that were sold-down last summer. Speaking of travel, airline ticket prices were up 7% in a sign consumers were not only ready to hit the road but also the air. Thus, Treasury investors held to the view that the bulk of the price gains are indeed transitory in nature and so the Fed’s rhetoric appears to be allaying inflation concerns for now.

CPI Price Gains Reflect Reopening Pressures

The essence of the Fed’s transitory argument as it relates to price increases is that there are several categories that have and will continue to see outsized demand as service-related businesses more fully reopen and as consumers return to activities that have been delayed or deferred over the last year. Other issues, like the used car story outlined above, provided another boost to prices. The Fed’s view is that these price increases will be temporary and not long-lasting, and that as consumers satisfy their delayed appetite for travel, eating out, etc., price pressures will abate. When looking at the categories that comprised most of the cost increases for May that argument certainly seems to carry some weight.


As the graph shows, of the 0.7% increase in the core rate of inflation for the month, nearly 0.4% came from used cars, new cars, and rentals. Airfares, hotels, and event admissions added just under 0.1% (and around 0.2% in April).   Combined, two-thirds of the core price increase can be traced to price pressures tied to pent-up consumer demand and to the unique circumstances surrounding the price increase in used cars. The graph also shows that these same categories were at play in the April CPI but to an even larger extent. Thus, we may  have already seen the peak in pricing pressure from pent-up consumer demand that should slowly ebb as the summer progresses and those deferred travel and spending plans are realized.

Median CPI Index Shows Modest Upward Price Pressure

The Cleveland Fed has been known as something of a pioneer in studying and tracking inflation and one of its more famous contributions is the Median Consumer Price Index. The Median CPI is the one-month inflation rate of the component whose expenditure weight is in the 50th percentile  of price changes. In other words,  when all category price changes are multiplied by their respective index weight the component with the product in the middle is the median price change. For May, that price increase was 0.3% (0.2635% to be exact).  Just as Core CPI takes out volatile categories like food and energy to smooth results, the median avoids the extremes of pricing on both ends regardless of the category. So what does a 0.3% Median CPI tell us? Well, it’s the highest monthly figure during the pandemic but it has been higher less than two years ago.  Bottom-line, it will have to climb higher if the Fed is to be shaken from its transitory mantra.


TIPS Inflation Breakeven Rates

Now that we’ve written about inflation more than enough, how are the markets reacting to the latest price-pressure read? We mentioned that nominal Treasury yields were lower despite the hotter-than-expected prints, but TIPS Breakeven Inflation Rates are continuing to trend lower as well. Recall that these breakeven rates are the CPI rate that will provide enough compensation to a TIPS buyer to generate an identical yield to a nominal Treasury. These breakeven yields peaked in May but have been trending lower.  What this implies, with a 5yr rate at 2.48% and 10yr rate at 2.35%, is that TIPS investors expect longer-run inflation to remain relatively benign despite the near-term inflation spikes.

Source: Bloomberg


Market Rates

Treasury Curve Today Chg Last Wk. LIBOR Rates Today Chg Last Wk. FF/Prime Rate Swap Rates Rate
3 Month 0.02% Unchanged 1 Mo LIBOR 0.07% -0.01% FF Target Rate 0.00%-0.25% 3 Year 0.391%
6 Month 0.04% Unchanged 3 Mo LIBOR 0.12% -0.01% Prime Rate 3.25% 5 Year 0.791%
2 Year 0.15% Unchanged 6 Mo LIBOR 0.16% -0.01% IOER 0.10% 10 Year 1.417%
10 Year 1.44% -0.12% 12 Mo LIBOR 0.24% -0.01% SOFR 0.01%


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Published: 06/10/21 Author: Thomas R. Fitzgerald