Mortgage rates jumped quickly higher yesterday following the higher inflation reading in the Consumer Price Index (CPI). Now today, rates have completely erased the move despite a similar report, the Producer Price Index (PPI) seemingly adding fuel to the inflationary fire. PPI is almost never as big of a deal as CPI when it comes to pushing rates around. That’s still true today, even though rates ultimately moved more than they did yesterday. Specifically, CPI resulted in a bigger, sharper initial move in the underlying bond market that was slowly backtracked afterword. Contrast that to today’s PPI which prompted a bond market shift that was less than half as big, but that happened to be followed by additional, gradual movement in the same direction.  Interestingly, PPI showed much higher annual inflation than expected, and that should have sent rates even higher.  The monthly PPI, however, was on-target.  More importantly, the components of the PPI data that have a bearing on core consumer inflation were much lower.   The bottom line to the paradoxical reaction is that math allows traders to get a really good idea of the forthcoming PCE data (yet another inflation report, and the one the Fed watches most closely) based on CPI and PPI. And in this week’s case, that math says PCE will be lower than previously expected.  When and if that’s revealed to be the case, it would provide a rate-friendly counterpoint to yesterday’s troublesome CPI data.  This is what the market was actually trading this morning as opposed to a PPI reaction in a vacuum. 

What’s Up With Today’s Paradoxical Bond Rally?

PPI may not be as heavy a hitter as CPI on average, but one could make a case for this week being one of the rare exceptions. Strikingly, PPI managed to HELP bonds despite the core annual number coming in much higher than expected. The catch is that January’s numbers were in line with expectations.  More importantly, the components of the PPI data that flow through to PCE inflation suggested bigger drop than expected when we get that data in 2 weeks (core PCE now seen around 0.25% for January as opposed to 0.35% before PPI). Today’s rally didn’t play out all at once like yesterday’s sell-off.  It gathered momentum heading into and out of the conclusion of this week’s Treasury auction cycle.  Nonetheless, PPI deserves most–if not all–of the credit for turning the tide. 

Econ Data / Events

Core Producer Prices, M/M

0.3 vs 0.3 f’cast
last month revised up to 0.4 from 0.0

Core Annual Producer Prices

3.6 vs 3.6 f’cast, 3.5 prev

Market Movement Recap

09:09 AM Modestly stronger overnight and gaining more ground after AM econ data.  MBS up 6 ticks (.19) and 10yr down 5.8 bps at 4.567

12:54 PM Additional gains into the 30yr bond auction time frame.  MBS up 3/8ths in 5.5 coupons and 10yr down 9.2bps at 4.533

03:09 PM More gains into 3pm, but bouncing a bit since then.  MBS up 13 ticks (.41)

This morning’s econ data included weekly jobless claims, which came in roughly in line with forecasts, and the Producer Price Index (PPI) which was a bit different.  The month over month change in core PPI was as expected, but the annual change jumped 0.3 above expectations (3.6 vs 3.3).  How can that be?  Revisions to the past 4 months affect the annual number without necessarily impacting the monthly number. In this case, both December and October were revised 0.1 higher, thus accounting for the 0.2 increase from last month’s 3.5% core annual PPI. 

Meanwhile, the monthly change in January was not only on target, but also good news for the components that flow through to PCE inflation (which the Fed watches more closely).

Jobless Claims were a non-event, but at least not showing additional labor market tightening.

The net effect in bonds is a relative sigh of relief after yesterday’s high alert following CPI.

Federal Reserve Chair Jerome Powell said insurance companies and banks are already pulling out of disaster-prone areas, which could pose problems.

The White House has tapped former Federal Deposit Insurance Corp. Director Jonathan McKernan to lead the Consumer Financial Protection Bureau and attorney Jonathan Gould to lead the Office of the Comptroller of the Currency late Tuesday.

The latest refinance surge helped lift total application activity up for a second straight week, even as purchases fell, the Mortgage Bankers Association said.

The company more than doubled results over comparable periods and exceeded estimates due to stronger economies of scale and valuation adjustments in its favor.

The Federal Reserve is set to refrain from cutting interest rates for “quite a while,” following a hotter-than-expected inflation report, according to Mohamed El-Erian.

CPI Came in HOT and Bonds Reacted Logically

There’s remarkably little else to observe beyond this morning’s initial commentary.  Bonds did exactly what we would have expected based on the sharply higher inflation reading with 10yr yields popping about 10bps higher and MBS shedding 3/8ths of a point, if there’s any new news, it’s simply that bonds managed to avoid any major additional selling pressure after the initial push in the first 2 hours of trading. Yields are closing out the day right in line with the levels seen 10 minutes after CPI came out.

Econ Data / Events

Core Monthly CPI

0.4 vs 0.3 f’cast, 0.2 prev
unrounded, 0.446

Core annual CPI

3.3 vs 3.1 f’cast, 3.2 prev

Market Movement Recap

08:38 AM Obliterated after CPI.  MBS down almost half a point and 10yr up 11bps at 4.639

01:05 PM modest recovery heading into 10yr auction, but losing some ground afterward.  10yr up 11.1bps at 4.638.  MBS down just over 3/8ths. 

02:52 PM Still relatively flat after initial selling.  10yr up 10.7bps at 4.635.  MBS down just over 3/8ths

We know that bonds take a majority of their economic data cues from two reports: NFP and CPI. We knew that today’s CPI was critically important in commenting on the potential “pause” of inflation’s descent back toward target levels. We also suspected, for a variety of reasons, that CPI could be an even bigger market mover than the jobs report. Unfortunately, it was.
Economists expected month over month core inflation to come in at 0.3%.  As it happened, it nearly came in at 0.5% (the unrounded number was 0.446%).  Used autos, housing, and medical services all played large roles in the surprise. The results keep the annual rate of change stalled out above 3%.

The bond market response was obvious, to say the least. 

Lastly, on the topic of CPI vs the jobs report, the torch has indeed been passed, although either report could cause a bigger reaction than the other if it were far enough from forecast.  That just happened to be CPI this time.