- Today’s CPI report could fuel fresh inflation worries
- 10-year T-note yield steady ahead of today’s auction
Today’s CPI report could fuel fresh inflation worries — The market’s recent inflation fixation means that today’s CPI report will receive a high degree of attention, even though the Fed’s preferred inflation measure is the PCE deflator.
The consensus is for today’s April CPI to show a smaller +0.2% m/m gain than March’s +0.6% m/m gain. However, the year-on-year CPI figure is expected to jump to +3.6% y/y from March’s +2.6% y/y due to a low year-earlier figure caused by the pandemic shutdowns.
Meanwhile, today’s April core CPI is expected to show a +0.3% m/m gain, matching March’s +0.3% gain. The core CPI on a year-on-year basis is expected to jump to +2.3% y/y from March’s +1.6% due to the low year-earlier base.
Due to the distortions from the year-earlier base, the markets will be paying more attention to the month-on-month and the 3-month annualized CPI figures. On a 3-month annualized basis, the March CPI rose by +5.0% and the core CPI rose by +1.9%. Today’s expected reports would produce 3-month annualized figures for April of +4.8% for the headline CPI and +3.0% for the core CPI.
Today’s expected 3-month annualized CPI report of +4.8% would be understandable due to this year’s surge in crude oil and fuel prices. However, the markets will not be happy to see the core CPI rise to +3.0% on a 3-month annualized basis, which would be well above the Fed’s +2.0% inflation target.
The Fed wants inflation to move mildly above +2.0% so that inflation over time averages out at the Fed’s +2.0% target. However, a +3.0% core CPI rate is likely higher than the Fed has in mind. The core PCE deflator in March already rose by +2.6% on a 3-month annualized basis.
Still, the Fed will be patient with the near-term inflation figures because Fed officials have repeatedly said that they expect the current inflation surge to be transitory. The Fed believes that the global trend towards disinflation remains in effect and that inflation will trend back down to 2% or below later this year and next year when the economy cools to more normal levels.
While the Fed says it isn’t worried, the markets are concerned that the Fed might be underestimating the inflation threat. If inflation starts to show a persistent rise above the Fed’s +2.0% target, the Fed will have no choice but to start tightening its monetary policy to prevent run-away inflation expectations, which are already high.
The 10-year breakeven inflation expectations rate on Monday rose to a new 8-year high of 2.59% and on Tuesday closed just 5 bp below that level at 2.54%%. That indicates that the markets believe inflation will average near +2.5% over the next ten years, which is substantially higher than the Fed’s +2.0% inflation target. High inflation expectations are a major bearish factor for the longer-end of the Treasury curve.
Inflation expectations are seeing upward pressure due to a variety of factors, including (1) supply chain bottlenecks and higher input prices for many businesses due to the surging economy, (2) this year’s surge in oil and gasoline prices, which is currently being made worse by the Colonial Pipeline shutdown, (3) strength in commodity prices in general, particularly with copper and lumber at record highs, (4) talk that higher wages may be necessary to coax workers back into the labor force, and (5) the Fed’s extremely easy monetary policy, which has produced the kindling that could cause an inflation outbreak in the future.
10-year T-note yield steady ahead of today’s auction — The Treasury today will sell $41 billion of new 10-year T-notes. The Treasury will then conclude this week’s $126 billion refunding operation by selling $27 billion of 30-year T-bonds on Thursday. The respective sizes of today’s 10-year and tomorrow’s 30-year auctions are unchanged from the Treasury’s last refunding operation in February.
The 10-year T-note yield yesterday closed mildly higher by +2 bp at 1.62%. The 10-year T-note yield has been trading mostly sideways in the past six weeks after posting a 15-month high of 1.77% in late-March. The 10-year T-note yield in Q1 surged as the Covid infection figures plunged and vaccinations rose, leading to expectations for an eventual full economic recovery.
T-note yields have also been pushed higher by the massive amount of fiscal stimulus in the economy. Washington has passed $5 trillion worth of pandemic aid and stimulus in the past year, with the latest $1.9 trillion installment just being passed in March. The markets also expect much of President Biden’s $4 trillion job and family plan to be approved by autumn or early winter, thus giving the economy another huge dose of fiscal stimulus.
The 12-auction averages for the 10-year T-note auctions are as follows: 2.42 bid cover ratio, $13 million in non-competitive bids, 5.0 bp tail to the median yield, 53.1 bp tail to the low yield, and 55% taken at the high yield. The 10-year is slightly below average in popularity among foreign investors and central banks. Indirect bidders, a proxy for foreign buyers, have taken an average of 60.8% of the last twelve 10-year T-note auctions, which is slightly below the median of 61.1% for all recent Treasury coupon auctions.
