“Whiplash,” read the title of one bank’s weekly compendium of global rates research.
It’s an apt, if overused, description. It’s also euphemistic. The rates complex is perilous. Bonds are a veritable minefield. Your safe-haven asset is now the proximate source of portfolio volatility. As one popular strategist put it last week, fixed income is a “disaster.” Those looking for solace aren’t likely to find it in the new week. There’s no rest for the weary, after all.
US CPI is on deck, which means sundry “peak inflation” narratives will be subjected to a trial by fire. March’s cooler-than-expected core print (and a subsequent “as-expected” read on core PCE) provided some cause for cautious optimism, as did a relatively tame read on average hourly earnings, but there’s ample scope for concern. Food, energy, housing and labor are all in short supply. The outlook is objectively bleak. Just ask the Bank of England.
Read more: Inflation May Be Here To Stay. 4 Reasons Why
Recall that although March’s US core CPI reading came in below consensus, the good news stopped there. The rest of the report betrayed a further broadening out of price pressures.
It’s with that in mind that consensus expects both the headline and core gauges to cool on a YoY basis, to 8.1% and 6%, respectively (figure below).
That opens the door to disappointments, even as there’s a strong mathematical case to made for an abatement in the annual prints. Traders will watch the MoM readings for evidence to support (or not) the “peak inflation” case.
“Within the details of the inflation data, robust gains in oil and food costs are all but a forgone conclusion, and we anticipate the more tradable new information will be how shelter costs have begun responding to average mortgage rates that are at their highest level since 2009,” BMO’s Ian Lyngen and Ben Jeffery said.
“Given the lagged flow through of home borrowing rates to real estate prices, and the even larger delay between home prices and OER, it is still too soon in the cycle to expect any significant pullback in the shelter subcomponent of CPI, but even a slower pace of gains would be an encouraging signal that peak inflation is nearing, or already in the rearview mirror,” they added. The figure (below) illustrates the point.
Recall that the latest S&P/Case-Shiller data showed the 20-city index rose more than 20% in February on an annual basis, the most ever. The national gauge wasn’t far behind. It’s too early to say whether shelter inflation has truly “caught up.”
“Rents are one of the components of the CPI for which the Phillips curve seems to work. Indeed, income growth is a leading indicator of the series,” Deutsche Bank’s Jiefu Luo and Justin Weidner said. “While our expectation is that rental prints stay near their current values for the rest of the year, there is some risk that the prints accelerate further should the labor market continue to tighten.”
Traders will have 24 hours to digest CPI before being compelled to parse April’s PPI report for confirmation that pipeline pressures persist. Suffice to say any upside surprises have the potential to spook a very nervous market. Jerome Powell attempted to rule out 75bps hike increments last week, but it was obvious by Friday that the market remains unconvinced that a predictable, 50bps cadence will be sufficient to rein in inflation. So, any escalations in the data risk knock-on escalations in STIRs and additional fireworks at the short-end.
“Volatility of two-year Treasury yields (both implied and realized) is now higher than any point in the last 18 years for a non-crisis period,” Deutsche Bank’s Steven Zeng remarked. The figure (below) gives you some context.
The implication is that there’s rampant uncertainty about the near-term course of monetary policy, which, I’d dryly note, is consistent with uncertainty among Fed officials themselves, who are flying just as blind as everyone else. This is a meeting-to-meeting environment. As Powell put it last week, it’s “very difficult to give forward guidance 60 or 90 days in advance.”
Given that, the utility of rolling out Fed officials for endless speaking engagements is questionable. But markets will hear from plenty of policymakers. On Tuesday alone, Williams, Barkin, Waller, Kashkari, Mester and Bostic will speak. At the peak last week, two-year yields were within 26bps of their 2018 highs.
Complicating this week’s rates trade is supply. “The timing of the fresh yield peaks coinciding with the May refunding auctions makes the sponsorship for the new issue supply particularly salient as a measure of dip-buying willingness at what will likely be the highest yielding 10-year auction since November 2018,” BMO’s Lyngen remarked.
All of this comes as an inexorable rise in US real rates continues to act as “gravity” for equity prices. 10-year reals are 130bps higher from two months ago. Five-year reals have risen 150bps in just 40 sessions.
To me, the figure (above) suggests equities have additional downside, especially when you consider the composition of the S&P 500. Yes, the most expensive names have de-rated materially YTD. But the shaded blue area in the chart represents a big tightening impulse over a very compressed time frame for a benchmark dominated by richly-valued, long-duration stocks.
Commenting further on volatility at the front-end, Deutsche’s Zeng wrote that the “wider range of views investors currently harbor about near-term monetary policy could make it harder for the Fed to achieve its desired policy setting with precision and consistency.” He continued:
Compounding the problem is the impossible task of knowing ahead of time what the neutral policy rate is, as well as greater uncertainties of fiscal policy at home and geopolitics abroad today. All these factors should make the Fed’s job of trying to slow the US economy without causing an accident that much more difficult.
Also on deck in the new week: NFIB (which sank to the lowest since April of 2020 in March), import prices and the preliminary read on University of Michigan sentiment for May.
