Markets are supposed to be forward-looking, so it’s a bit of a mystery that bonds sold off as dramatically as they did on evidence that bad first-quarter inflation was worse than previously understood. It’s tempting to brush it off as an overreaction to old news, but we still don’t know just how outdated it is.
As part of its broader report on gross domestic product, the Bureau of Economic Analysis said Thursday that a gauge of core personal consumption expenditures prices rose at a 3.7% annualized clip, the first quarterly acceleration in a year. That, in turn, sent yields on 10-year Treasury notes as high as 4.74%, the highest since Nov. 2, driven by the narrative that inflation is getting stuck at a level still well above the Federal Reserve’s 2% target.
The number, of course, added insult to injury. The closely watched monthly measures of personal consumption expenditures inflation had already indicated a hot January and February, and most signs suggest that March remained on the warm side (with the report due out Friday; economists forecast it rose 0.3% month-on-month.) But using deductive reasoning, the quarterly price index suggests that either March will come in higher than expected or January and February are due for upward revisions. The answer will matter tremendously for the direction of markets.
Here’s how Inflation Insights LLC President Omair Sharif described the two potential scenarios (emphasis mine):
First [scenario], prior months were unrevised but the March core is likely to be much stronger than the 0.3% reading expected tomorrow. This seems highly unlikely. Second, there were upward revisions to prior months due to new seasonal factors. I think the latter explanation is the main reason today’s quarterly annualized reading beat expectations. In my view, the upside surprise most likely reflects stronger core services inflation throughout the quarter as opposed to a much stronger-than-expected March core print with no revisions to prior months.
Here’s hoping Sharif is right, because momentum is everything.
Markets should be relatively willing to look past ugly January and February prints, because they reflected a perfect storm of unfavorable dynamics that could now be fading. There were idiosyncrasies affecting housing and financial services; conflict in the Red Sea hit shipping costs; and — perhaps most controversially — there may have been an “excess seasonality” effect, whereby companies frontloaded many of their price hikes in a way that isn’t necessarily indicative of future pricing plans. On the other hand, a hotter-than-expected March could indicate a more durable trend, pouring cold water on these efforts to explain away the January and February numbers.
In essence, it could mean that the past is prologue; that a remarkably strong stock market may have goosed financial conditions; and that elevated bond yields may be poised to stay on the high side for the time being. It might also mean that Fed policy rates remain on hold at 5.25%-5.5% for the rest of the year, instead of the two-three cuts that markets were expecting earlier this year.
Personally, I still think there are a lot of reasons to remain optimistic. Friday’s core PCE report is perhaps the most important of the inflation indicators, because it’s the one that the Fed primarily uses to conduct monetary policy. It’s also the last of the inflation reports published during the course of the month, and economists can generally predict it with a high degree of accuracy once they’ve seen the related consumer price index and producer price index.
And since the last CPI data was published, we’ve gotten a lot of good news from high-frequency indicators: used car prices at auction have continued to drift down; the new tenant rent index (which is predictive of future shelter inflation) continued to drop; and container freight rates that surged amid conflict in the Red Sea have begun to normalize. In other words, bad news isn’t so bad if it also proves to be old news. But we’ll have to wait until Friday to find out just how old it is.
A message from Advisor Perspectives and VettaFi: To learn more about this and other topics, check out our podcasts.
Bloomberg News provided this article. For more articles like this please visit
bloomberg.com.
Read more articles by Jonathan Levin
