Inflation was Heartbreak Hotel for Bonds

This has been a tough week for bond and interest rate markets:

• We saw two important November inflation reports: Consumer Price Index (CPI) and the Producer Price Index (PPI).
• We received the normal weekly jobless claims: Initial and Continuing. These claims were both higher showing continued weakness in the job markets. 
• We also had a strong 10-year treasury bond auction.
• Both the jobless claims and the treasury auction were good for interest rates, but they couldn’t shake the damage that came from the inflation reports.

CPI measures the changes in the price of consumer goods and services and calculates an index to show how all prices are changing. 

The headline numbers came in slightly hotter and higher than expected with the monthly number showing an increase of 0.3% for November versus 0.2% expected and yearly inflation rose from 2.6 to 2.7%.

• Food prices were higher and accounted for much of the rise. 
• Eggs rose 52%! 
• The Core Rate — stripping out volatile food and energy costs — rose 0.3% in November and yearly remained unchanged at 3.3%, both as expected. 

A significant portion of the increase — almost 50% — comes from housing and shelter costs.  

Finally, the report started to show similar results from other economic housing reports in that rents are not rising very fast. This report has been significantly lagging behind current data and was showing stubbornly high rent costs. If shelter costs were caught up with the current reporting, Core CPI would be at 2%, exactly where the Federal Reserve (“the Fed”) is targeting. An often-overlooked component of shelter is Lodging Away From Home. This measures hotel costs and other transient housing. It actually accounted for 20% of this month total inflation. This is a huge increase from this small component.  Hotels really gave us some heartbreak in rates this week. Big thanks to Barry Habib and his team at MBS Highway for pointing this out.

PPI measures the changes in the price of wholesale goods and services.  

Wholesale means the prices of goods and services before they get to an end consumer. These price changes don’t always flow through to the consumer, but they eventually do if the price change remains high or low for an extended period of time. 

If the cost of lumber to a sawmill goes up, eventually they will pass this on to construction companies.

• PPI for November rose 0.4%, much hotter than 0.2%.
• Yearly, we saw an increase from 2.6% to 3%. 
• Last month’s report was revised from 2.4% yearly so this means it was an actual increase from 2.4% to 3%. That is a huge number.    

Looking Ahead: 

Next week is the final Fed meeting of the year and a much-anticipated rate decision. Will it be the final cut of the year, or will they push it off to next year?

• Tuesday: Retail Sales
• Wednesday: Fed Meeting, Housing Starts and Permits
• Thursday: Final Q3 GDP, Existing Home Sales
• Friday: Personal Consumption Expenditures (PCE — the Fed’s favorite inflation report)

Let’s hope the rate markets can get some good news next week and reset their trajectory lower. This wasn’t a fun week for rates!