Houston's Rate Sheet

CPI is higher than expected

After yesterday’s relatively flat Producer Price Index, bond prices moved higher and bond yields fell. All that went away, after today’s release of the Consumer Price Index. CPI is the most popular of inflation metrics, and it came in a little higher than expected. In response, bonds gave up their gains and fell in price, which led to higher yields. For the week, it appears to be a wash for mortgage rates, but it probably means that the Fed will raise rates again and cause rates to continue their rise.

Here's a Reuter's article with more detail about today's events:

U.S. Treasury prices reversed a two-day advance on Wednesday after sharper-than-expected increases in April consumer prices made further Federal Reserve interest-rate hikes look more likely.

A 0.3 percent increase in the core Consumer Price Index in April alarmed inflation-conscious bond investors who were soothed just a day earlier by a more benign than expected 0.1 percent increase in the core Producer Price Index.

"Investors have a high sensitivity to signs of inflation now, so bonds moved lower on this number because it argues that the Fed could keep raising interest rates," said A.G. Edwards and Sons senior economist Patrick Fearon.

"The core number for CPI had been stuck on 2 percent year-over-year for nearly a year, but is now at 2.3 percent year-over-year," said Gregory Miller, chief economist at SunTrust Banks in Atlanta, Georgia. "We've now had three core CPI readings in a row which are above a previously almost flat trend and the market is finally starting to notice that."

Miller said the uptick in inflation would complicate the job of Fed monetary policy-makers.

"The Fed has already acknowledged that the growth side of the economy is showing some chinks in its armor," Miller said. "There is some early impact on household budgets from the need to spend more on energy and less on other consumption."

"That puts the Fed in the position of having to balance (addressing) a slowdown that's already started with the prospect of prices coming up as well," Miller said.

In late trade, fed funds futures markets reflected a 50 percent chance that Fed policy-makers would boost rates again when they meet in late June, up from 38 percent on Tuesday.

The Fed raised its benchmark fed funds rate to 5 percent earlier this month, its 16th rate hike in nearly two years.

"If the (inflation) news continues to be bad, the Fed will have to get back on the tightening bandwagon after the June meeting," said Craig Coats, co-head of fixed income at Keefe, Bruyette & Woods in New York.

Many analysts believe the Fed will refrain from raising rates in June, pausing instead to see what impact nearly two years of monetary tightening will have on economic growth.

At 3 p.m. (1900 GMT) benchmark 10-year U.S. Treasury notes were down 16/32 in price, their yields rising to 5.17 percent from 5.10 percent late Tuesday.
Two-year Treasury notes slipped 1/32, their yields rising to 4.97 percent from 4.95 percent late Tuesday.

The 30-year bond lost nearly a full point, its yield rising to 5.28 percent from 5.21 percent on Tuesday.

The year-over-year core inflation rate of 2.3 percent as of April was above the Fed's perceived "comfort" zone of between 1 percent and 2 percent, analysts said.
Tuesday's rise in Treasury debt prices was fueled in part by data showing a 7.4 percent April decline in housing starts. The government report supported the view that the key economic sector would slow overall growth and force the Fed to stop raising interest rates.

However, a mortgage industry survey released on Wednesday showed there is still life in the housing market.

The Mortgage Bankers Association's index climbed last week despite rates on fixed-rate mortgages approaching 4-year highs. The group's weekly gauge of mortgage activity was up 4.6 percent from the previous week.

posted by Vincent Biondillo @ 3:17 PM