#39 S2N: Inflation: Yes or No

Today’s Spotlight

The CPI monthly figures were released yesterday, and they caused quite a stir. The market has been anticipating many interest rate cuts this year; I think it was 5. Then it got revised down to 3. Now 2 and some are saying the next move by the Fed will be a hike. Yikes!

Let us go through the numbers.

We start with the YoY CPI numbers. This is a monthly release, so it is the month of March 2024 over March 2023. The number was higher than expected at 3.48%, the average over 75 years has been 3.54%.

The chart below shows the more volatile metric of the month on the previous month. The monthly inflation came out at 0.38%, which is above its monthly average.

We now progress to look at headline inflation versus the core. Headline includes all the various components of inflation, and core strips out more volatile items such as food and energy. Headline stopped dropping, but core is still trending down.

At this point, I want to highlight what the response to the higher-than-expected inflation did to the bond market yesterday. Yields jumped up on the day, as you can see with the dark green shading.

If you look at the Fed Fund Futures, you will notice a massive change in shape from a month ago. I promise to make this chart easier to understand next time, but this is how it is actually priced. The price for the nearest date of the FFR future is 94.7, which means the future is trading with an expected interest rate of 100 – 94.7 = 5.3%. If we go to the end date and look at the blue last dot, it is telling us that the market is expecting at the end of 2025 the interest rate to be trading at 100 – 95.52 = 4.48%. A month ago, the market was anticipating 100 – 96.21 = 3.79%, so you can see in the short space of a month there has been a big change in expectations around inflation.

Let us look at another way of expressing what the market thinks about inflation expectations. I am going to focus on just one of the lines, the red one, which is the 5-year breakeven inflation rate. This is calculated by taking the yield on the 5-yr treasury yield less the 5-yr tips yield. (Tips are inflation adjusted treasuries, I will probably need to explain this in more details in a blog for some of you.) In essence the market is expecting inflation to be 2.49% in 5 years.

Performance Review

To learn a bit more about the Z-Score, which I use for the colour signals, read this blog post.

Chart Gallery

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