Houston's Rate Sheet

Inflation uncertainty pushes Treasury yields back up

Huh? What is going on with inflation? Those are the questions the market is mulling over at the moment. After a great Consumer Price Index (CPI) report last week, the Producer Price Index showed higher than expected inflationary pressure. A sharp drop in energy prices caused big declines in producer prices, which by itself sounds like good news. However, "core" PPI, which excludes more volatile food and energy prices, increased much higher than Wall Street had forecast. This caused Treasury bond prices to fall and their yield to rise. A bond's price and yield move in opposite directions. As reported by Reuters at 11:28 a.m., the benchmark 10-year Treasury note fell 14/32 in price, pushing yields up to 4.72 percent from 4.66 percent. You can expect overnight mortgage rates to move in the same direction.

For a more detailed analysis of today's Producer Price Index report, here are some comments from Joel Naroff, Chief Economist for Commerce Bank:

WHAT IT MEANS: A strange winter has led to some strange changes in wholesale prices. The Producer Price Index fell sharply in February as both energy and food cratered. But excluding these factors, prices rose a bit faster than expected. So what is going on here? First, there’s energy. It was down sharply but has rebounded, so watch out for the March number. As for food, those prices fell a huge amount as well. Just about every food product was down, which is absolutely amazing. I can understand vegetables, as the hurricane impacts are now behind us. But eggs, chickens, turkeys (no, I don’t think it’s due to bird flu scare), dairy and even confectionery product prices were off. I can’t explain that. As for non-food and energy (core) prices, they rose moderately for the third time in four months. That included consumer goods and capital equipment. Looking at the pipeline, pressures are building. Core prices continue to rise faster than would be considered comfortable and at the intermediate level they have been surging for the past six months. That is a warning sign, though as I say every month, the pathway from wholesale to retail prices is about as clear as mud.

MARKETS AND FED POLICY IMPLICATIONS: The Fed continues to focus on inflation and while wages may be the key concern, further rises in wholesale prices cannot make the FOMC members sleep comfortably. The issue though, is how much gets passed through. That is more a matter of pricing power. But if wages and input costs are rising, then the stage is set for an uptick in inflation. A rate hike is expected at next week’s FOMC meeting and if I read Mr. Bernanke’s speech correctly, the bias may be toward somewhat higher rates. But if anyone really thought Mr. Bernanke would be clearer than Mr. Greenspan, they were kidding themselves. Instead of density, we now have academic obfuscation. Meet the new boss, same as the old boss.

posted by Vincent Biondillo @ 2:48 PM