CPI prints at decade high while Treasury yields plummet to quarterly lows
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Inflation data last week printed at the highest level since 2008 as investors weighed its transitory nature. Signaling expectation of continued dovishness by the Fed amid economic reopening, stocks hit record highs. Curiously, Treasuries also rallied as yields fell to three-month lows.
Investors look to granular-level data for inflation clues
As economic reopening in the United States has coupled with the unleashing of pent-up consumer demand, all eyes have focused on inflation data. Exceeding expectations, the year-over-year Consumer Price Index released last week showed a 5.0% increase in prices for the month of May, the highest print since 2008. Core CPI—which excludes the volatility associated with food and energy prices—came out at 3.8%, the highest level since 1992. Often, because inflation erodes the value of bonds held outright, investors will sell bonds; interestingly, Treasury yields fell 12 basis points over the past week, suggesting significant bond-buying activity as the 10-year yield fell to its lowest point since early March.
At the same time, investors appeared comfortable adding risk to portfolios as equities rallied and the S&P 500 hit all-time highs. Consensus at the moment is the market agrees with Fed’s characterization of inflation as “transitory.” Not only do year-over-year inflation figures continue to base off the lower levels seen last Spring, the granular-level inflation data suggest much of the price increase is concentrated in sectors associated with economic reopening. Vehicle purchases (new and used) and vehicle rental prices all increased on a month-over-month basis, as well as airline fares, which increased 7.0%. Beyond that, ongoing supply pressure in lumber and other manufacturing industries continues to push inflation higher.
Consumer sentiment data appears to corroborate investor sentiment on inflation
Consumer sentiment data released on Friday also show that consumers themselves have tempered inflation expectations: consumers expect 4.0% inflation over the next year, a decrease from 4.6% seen last month. Expectations for inflation over the next five years also fell from 3.0% last month to 2.8% this month. Coupled with that, the University of Michigan’s consumer sentiment index showed an increase from the prior month, a sign that consumers are increasingly optimistic and not overly worried about inflation.
Central banks continue bond-buying programs
While the market ponders the timing of potential asset purchase tapering by the Federal Reserve, the European Central Bank (ECB) pledged on Thursday to accelerate its pace on bond purchases in Europe, thus expanding their current quantitative easing program. The announcement came even amid a positive outlook for growth in the European region, reflecting the balance between surging demand and ongoing pandemic risks. This appears to have paused the strengthening trend in the euro versus the dollar, which weakened slightly to 1.21, its lowest level in about a month.
LIBOR grinds to all-time lows
Consistent with the trend of the last few weeks, LIBOR and other short-term rates continued to compress to all-time lows as financial-sector demand for short-term cash deposits seemingly exceeds available supply. Indeed, 1-month and 3-month LIBOR were published at lows 0.0726% and 0.1189% on June 10 and 11, respectively. This came in concert with banks utilizing the Fed’s reverse repo facility to a tune of roughly $500 billion per day at 0% interest, as discussed in our June 1 market update. The market will look to the Fed’s June meeting for any tweaks to the RRP rate or interest on excess reserves (IOER) that may tilt the balance for short-term rates.
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