Bond Market Keeps Inflation Expectations Elevated After CPI Data

Bond traders are keeping their expectations for medium-term US inflation at elevated levels as signs of persistent price pressures suggest the Federal Reserve has more to do in terms of tightening policy.

(Bloomberg) — Bond traders are keeping their expectations for medium-term US inflation at elevated levels as signs of persistent price pressures suggest the Federal Reserve has more to do in terms of tightening policy.

While the rise in the consumer price index for January matched consensus estimates, revisions left year-on-year rates higher than economists expected. The report showed disinflationary momentum in core goods is flagging. And the so-called super-core figure — or core services minus housing, an indicator watched closely by Fed Chair Jerome Powell — was sticky, increasing at a slower 0.27% pace for the month but running at a 6.2% pace from the prior year.

After a blowout January jobs gain, the slow progress in the taming of inflation suggests the Fed may need to tighten policy beyond its peak estimate of 5% to 5.25% and keep rates elevated for an extended period in order to tame stubborn price pressure.

In the wake of the CPI report, the so-called breakeven rate for five-year inflation-linked Treasuries – a proxy for inflation expectations over that time – remained above 2.5%, the highest since Dec. 5. The benchmark has climbed steadily from its mid-Jan low of 2.13% as jobs and inflation data suggested a lot more resilience in the economy than what the bond market expected at the start of the year.

Still, the prospect of a more aggressive Fed tightening campaign from here is helping contain longer term expectations for inflation. A gauge for 10-year inflation-linked bonds showed a breakeven around 2.32% on Tuesday after the CPI report, holding below its recent high of 2.36%. A smoother measure of inflation expectations, five-year five-year forward breakeven was trading around 2.14% on Tuesday, down from a late January peak of 2.32%.

In the coming week, the focus will turn to the release of the producer price index for January and the minutes from the Fed’s meeting that concluded on Feb. 1 for insight from officials about the path of policy and the inflation trends.

After the CPI data, swaps traders see the interest rate set by the Fed climbing to a peak of about 5.29% in July, marking a new cycle high, and holding above 5% all year. The pricing in swaps implies quarter-point increases at the March and May policy meetings, and roughly even odds of another such move in June.

The following is a series of indicators on how the market views US inflation:

Inflation Snapshot

Inflation News

The US consumer price index climbed 0.5% in January, the most in three months and bolstered by energy and shelter costs
The average monthly payment for a new car has soared to a record $777, nearly doubling from late 2019, according to Kelley Blue Book owner Cox Automotive
A Federal Reserve Bank of New York’s survey of consumer expectations shows Americans anticipate income growth to slow and inflation to stay elevated
UK wages rose quicker than expected at the end of 2022, heaping pressure on the Bank of England to deliver another interest-rate increase next month
At least two dozen nations queuing up before the IMF for rescue packages, and currency traders are bracing for a potential fresh wave of devaluations in the developing world

Key Upcoming US Releases

Feb. 16: Producer Price Index for January
Feb. 17: Import and Export Price Indexes for January
Feb. 22: FOMC meeting minutes (Feb.1)
Feb. 23: GDP report for fourth quarter (second reading)
Feb. 24: Personal income and spending report for January; U. of Mich inflation
March 10: Monthly jobs report, including average wages data, for February
March 22: Federal Open Market Committee policy decision

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