Hotter inflation likely to keep rates higher
Summary
CPI and PPI caught the attention of investors last week as they both were hotter than expected. The market’s initial reaction to the CPI report sent the 10-year Treasury yield higher by ~10 bps, closing at 4.63% on Wednesday. However, by the end of the week, as the markets had time to digest the inflation reports, the news out of Washington (tariffs, Russia/Ukraine peace talks, Chair Powell’s testimony), and retail sales, the 10-year Treasury yield retreated sharply, closing the week at 4.48%.
Inflation
The much-awaited CPI and PPI reports were released last week, giving investors a current look at the inflation picture, which at first glance was not promising. CPI was well above expectations with the annual rates for headline and core inflation at 3.0% and 3.3%, respectively. Taking a closer look, it was more than the 15.2% surge in the prices of eggs that drove inflation. Energy, used cars, car insurance, and shelter were all higher on the month. The media jumped on this as an opportunity to highlight the fact that the Fed is unlikely to lower rates as a result of this report, which is likely true for the short term. However, other factors should be considered. It is important not to extrapolate too much from any one report, especially one that has shown larger than expected seasonality adjustments in the past. Furthermore, we know it takes time for many items, such as shelter, to work through the CPI report. When looking at shelter, it is interesting that the CPI report showed an uptick, when the January release of the BLS/Cleveland Fed New Tenant Rent Index showed a decline in new rents of -2.4% year-over-year. CPI shelter readings typically lag this index by about nine months, and this decline is notable as shelter makes up almost 40% of CPI, so there may be downward pressure in the CPI shelter readings in the coming months. While we can’t predict the future, there will likely be increased volatility in rates given the number of diverging factors that can drive large moves, especially on the long end of the curve.
Source: BLS
Other key economic releases and news
Outside of the inflation reports, there were other notable releases and news over the week. The NFIB Small Business Optimism Index was released, showing a lower than expected reading of 102.8 after a higher than expected prior reading of 105.1. Jobless claims declined to 213,000, down from last week’s 220,000 claims. Most notably, retail sales were well below expectations with the headline reflecting a decline of -0.9% on the month. Excluding vehicles, the reading of -0.4% on the month was better, but again, substantially missed expectations. While retail sales numbers are volatile and subject to large revisions, this is worth paying close attention to as it may be a sign the resilient consumer could be slowing. As inflation has remained stickier, a consumer slowdown would be unwelcome news.
There was also other market-moving news on the week. Of course, tariffs made headlines with the announcement of 25% tariffs on steel and aluminum and reciprocal tariffs, although the details won’t be released for a few weeks. President Trump also announced that he expected Russia/Ukraine peace talks to begin immediately after his call with Vladimir Putin. Oil prices declined ~-2.5% in response. Finally, Chair Powell testified before the Senate Banking Committee last week, highlighting that the Fed is not rushing to cut rates.
The week ahead
Next week will be a relatively light week, with housing starts, Fed minutes, and S&P PMIs set to be released.
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