Rates May Be Poised For A Major Move Higher Amid Sticky Inflation - Seeking Alpha

Rates May Be Poised For A Major Move Higher Amid Sticky Inflation | Seeking Alpha

Rates May Be Poised For A Major Move Higher Amid Sticky Inflation

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USMC,

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USVM 6 Comments

Summary

- Inflation accelerated in August, posing a potential problem for the rest of 2023.
- Rising oil and gasoline prices may further contribute to inflationary pressures.
- Rates on the long-end may be ready to break out and rise to levels not seen in a decade.
- Looking for a helping hand in the market? Members of Reading The Markets get exclusive ideas and guidance to navigate any climate. Learn More »

Lemon_tm

The latest CPI data showed that inflation accelerated in August and is likely a problem as we move through the balance of 2023. This will especially be true if oil and gasoline prices continue to rise. This will likely push rates on the back of the curve higher, which could be a signal from the market that monetary policy is not restrictive enough.

In August, the CPI rose by 0.6% month over month, in line with expectations, while core CPI came in hotter than expected, rising by 0.3% m/m vs. expectations for 0.2%. Finally, headline CPI rose by 3.7%, higher than estimates of 3.6%, while core CPI came in line at 4.3%. Hotter-than-expected retail sales, producer prices, and import prices followed this.

3.5% Inflation Rate

The stronger data should continue to support a higher for longer policy from the Federal Reserve and, more probably than not, suggest the Fed is not done raising rates, especially if we continue to see headline inflation move up and get stuck around the 3.5% level, as swaps and models are suggesting could be the case.

Bloomberg

A stickier higher inflation rate seems possible, especially given that oil and gasoline prices continue to rise and ripple through different parts of the economy. Meanwhile, wage growth has been consistently around 4% for months, which is still not consistent with a 2% inflation rate.

The CPI report also reveals that CPI core services less shelter rose by 0.5% in August, its largest jump since September 2022. It also rose by 4.1% y/y, up from 4.02% in July and 3.94% in June.

Bloomberg

Resetting Inflation Expectations

As a result of this hotter-than-expected inflation, coupled with rising commodity prices, the market is resetting short-term breakeven inflation expectations. The two-year breakeven inflation rate has recently climbed to its highest level since April, increasing to roughly 2.2%. The move higher in inflation expectations would suggest that the market is thinking that perhaps rates aren't sufficiently restrictive to contain inflation. If this breakeven rate were to continue to climb, it would only strengthen the case for more Fed rate hikes beyond the one potentially coming in November.

Bloomberg

This also has led to inflation swaps pricing in higher inflation rates for the balance of 2023. Swaps for September are trading around 3.5%, October and November are pricing at 3.1%, and December is now up to around 3.3%. These have all steadily increased since the end of August and have continued to push higher recently.

Bloomberg

Additionally, nowcasting models also forecast higher inflation rates for the month of September as well. Bloomberg forecasts a 3.75% increase, while Kalshi currently projects 3.59%, and the Cleveland Fed is at 3.66%, which would be basically in line with the August CPI headline print. Again, it isn't the inflation rates being modeled, but the trend, and that trend shows expectations rising. Clearly, the risk is for further upside on these projections should things like oil and gasoline continue to climb in the weeks ahead.

Bloomberg

Higher Long-End Rates

This is primarily why the market seems to be saying that monetary policy is not restrictive enough, which could result in rates on the back of the curve only continuing to rise from their current levels.

Technically, the 10-year and 30-year rates look poised to break out to new cycle highs and may only need a nudge to really get them higher from current levels.

TradingView

The 10-year is again back to highs around 4.35% after backing off some, and if it climbs above that level of resistance, it could be off to the races, rising to the next major level of resistance not seen until around 4.7%, a rate last seen in October 2007.

TradingView

The same can be true of the 30-year bond, which has risen back to its highs near 4.4%. If that resistance level is broken, the next one doesn't come until 4.8%, a level not seen since February 2011.

TradingView

Rising nominal yields are also likely to lift real yields to some degree. The 10-year TIP rate has been trading around 2% for some time, and one would think that if the 10-year nominal breaks highs, the 10-year TIP could move sharply above 2%.

Bloomberg

The most important thing about the inflation rate is the trend, and the trend for inflation, which had been steadily heading lower, is no longer doing that, at least over the next few months based on estimates and market pricing. It seems to suggest that inflation is expected to move sideways for some time, which probably means that rates on the back of the curve need to rise to adjust for the rising inflation expectations from the market.

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This article was written by

I am Michael Kramer, the founder of Mott Capital Management and creator of Reading The Markets, an SA Marketplace service. I focus on long-only macro themes and trends, look for long-term thematic growth investments, and use options data to find unusual activity.

I use my over 25 years of experience as a buy-side trader, analyst, and portfolio manager, to explain the twists and turns of the stock market and where it may be heading next. Additionally, I use data from top vendors to formulate my analysis, including sell-side analyst estimates and research, newsfeeds, in-depth options data, and gamma levels.

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