Rates Spark: Assessing the End-of-Cycle Vibes and Market Reactions
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Rates Spark: Are we there yet?
The CPI surprise will not keep the Fed from hiking rates this month, but further hikes look less likely. Today's PPI may give markets another excuse to trade the easing inflation narrative, with front-end-led steepening sending end-of-cycle vibes. Today's ECB minutes will pit a hawkish stance against signs of easing inflation pressures.
US CPI surprise gives markets end-of-cycle vibes
There was something in the air in the past few trading days. Just when 4% on the 10yr was looking comfortable, there was a pivot of attention towards yesterday's CPI report. Consensus pointed to a low 3% headline number. But we got better. Bang on 3%, so close to a break into a 2% handle. And, the core rate gets back below 5% for the first time in a year and a half. A good look for inflation overall, and correlating with market rates heading decisively lower.
The 10Y US Treasury is now below 3.9% and the 2Y closer to 4.70%. The curve dis-inverted, this time in bull-steeping fashion as one would expect towards the end of a tightening cycle. Both real yields and inflation expectations ease lower. The 2Y breakeven rate has dipped back below 2%, a very comforting reading from the Fed’s perspective.
The question now is whether the market continues to trade off the easing inflation narrative. There is an excuse to do so as today’s PPI report is also expected to be friendly. It’s quite a swing from the strong wage data last week into an easing inflation narrative for this week. Both are in fact backward looking, but the core inflation reading in particular is the dominant driver for market rates. If the market begins to believe that easing pipeline pressures and the pull of lower headline rates can dominate, then the strong labour market backdrop can be downsized as an issue.
It is tough to make a conviction-directional view from here. We had been consistently looking for a break above 4% and to stay above that level for a while. But we are clearly back below, and with some reasonable justification.
Front-end led steepening signals end-of-cycle vibes
