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What a difference a month makes.
In May, US CPI rose to 8.6% compared to 8.3% and 10-year Treasury yields surged to 3.50% from 3.02%.
This time around CPI was at 9.1% compared to 8.8% expected. 10-year yields initially moved to 3.07% from 2.95% but have since reversed and are now below the pre-CPI level at 2.91%.
Why the difference?
Three main reasons:
1) Fed cred
The market is now convinced that the Fed is willing tackle inflation no matter what it takes. 5-year, 5-year forward breakevens have come down to 2%.
2) The BOC decision
Modern central banks are a school of fish, they move together. The surprise BOC 100 basis point hike shortly after the CPI report cleared a path for the Fed to do the same. Underscoring the first point, the market is now pricing in a 55% chance of a 100 bps hike, up from a negligible level before the report. That will likely be coupled with similar messaging to the BOC, where it’s touted as front loading rather than a signal about higher terminals rates. If anything, BOC Governor Macklem tried to spin it as a sign that terminal rates will be lower.
3) Global growth deterioration
The market is increasingly convinced that growth is slowing rapidly. Bank of America economists today shifted their forecast to a US recession and the IMF warned the outlook has ‘darkened significantly’. In addition, the potential for a Russian cutoff of European natural gas would ensure a brutal recession there. The thinking is that slower growth will certainly curb inflation and that getting paid nearly 3% for the long term isn’t a bad return because inflation will be transitory.