Was yesterday a day of significance? The CPI was nominally lower than expected. The core rate climbed by 0.2% from April and 3.4% year over year, the slowest pace in more than three years. Analysts had expected a 0.3% and 3.5% pace, respectively. The headline rate was also lower than expected by 0.1%, posting a 0.0% monthly increase and a 3.3% y/y gain.
All markets advanced off this data believing that inflation will again begin to abate to the 2.0% FOMC targeted rate.
The more hawkish outcome of the FOMC meeting was shrugged off. The dot plot or the anonymous survey as to where the respected members think interest rates will be at a period of time indicated only 1 interest rate reduction in 2024, down from three expected several months ago. However, the Committee now thinks there will be four cuts in 2025, more than the three previously outlined.
The more hawkish pivot was dismissed under the simple guise of perhaps more later.
Before the decision, the markets were suggesting that the Fed would cut rates twice by year end and as a high like hood of a first cut occurring as soon as September, the result of the CPI report.
Officials also raised their projections for where interest rates will be in the longer term to 2.8% from 2.6% at the March gathering.
Will this outlook materialize? The Federal Reserve’s [and Wall Street] outlooks have completely missed their marks. Almost four years ago the Committee stated it would permit inflation to run at a higher rate for a prolonged period without changing monetary policy.
Until March 2022 the Central Bank adamantly stated inflation was transitory, and the overnight rate would remain around 0.00%. In March 2022, the Committee radically changed its view but stated the overnight rate may not go above 0.5%.
As widely known inflation surged to several decade highs and there was a radical change in monetary policy where the overnight rate was increased to around 5.25% by July 2023.
The Federal Reserve’s [and Wall Street] also completely missed the mark in 2023 and thus far in 2024.
At the beginning of the year Wall Street had forecasted seven interest rates cuts in 2024, at odds with FOMC’s outlook of three or four.
The unique aspect of this cycle is that longer dated Treasuries have not risen by the amount one would have expected. According to the St. Louis Fed, the 10-year Treasury historically yields about 2.87% above the inflation rate thus suggesting a 10-year Treasury yield around 6.5%.
Why the disconnect especially as longer dated mortgage rates responded accordingly?
According to Bloomberg data, the CPI fixing swaps is suggesting the 12-month inflation rate will be 3.35%. Inflationary expectations suggest however suggest inflation will slow below 3% in July reaching 2.4% in 12 months, a view that is also different from sentiment surveys which are suggesting that inflation will be nominally higher than today’s levels.
Longer term Treasuries trade upon current and future inflationary expectations. This is perhaps the first cycle in history that longer dated Treasuries have not responded accordingly, a remarkable occurrence given the massive increase in the deficit and unsustainable fiscal policy.
Today will be studied for many years.
Commenting on the markets, the Treasury market surged with the yield curve steepening. The NASDAQ surged almost 1.5% and the Dow was essentially unchanged.
What will happen today? The PPI is released at 8:30
Last night the foreign markets were down. London was down 0.51%, Paris down 1.37% and Frankfurt down 1.12%. China was down 0.28%, Japan down 0.40% and Hang Seng up 0.97%.
Futures are bifurcated as Dow futures are down 0.3% while NASDAQ futures are up 0.60%, perhaps on monetary policy optimism. The 10-year is up 1/32 to yield 4.31%.
