The Daily Update - CPI retail sales bond yields

Yesterday was another painful day for bond investors as CPI for January came in at 0.5% MoM and the ex food and energy measure went from 1.7% to 1.8% YoY, a strong release. We also had the retail sales readings which was largely ignored by the market even though December was revised to 0.00% from 0.4% and January came in at -0.3% versus expectations of +0.2%. Inflation clearly won the day with 10-year Treasury note yield up at 2.92% this morning, a rise of 9bps from early yesterday in London.

We had expected inflation to bounce at the beginning of the year, and still remain of the view that it is a short-term theme as there are several indicators (such as vehicle sales and mortgage delinquencies for example), which paint a much more pessimistic view of the economy. But obviously the market has reacted more than we had expected over the last several weeks, not helped by the high level of funding.

We do think the Fed will continue to tighten especially if we see inflation pick up further, and that along with their balance sheet management will combine to move us closer to the end of this cycle which is now in its 104th month of expansion. For the cycle to really start turn we would need to see a prolonged or very sudden decline in equity markets, and until and unless that happens consumer confidence will likely remain relatively high.

So, a difficult month for us so far and our long only portfolios but we still believe that this is an inflationary blip not a constant move higher in prices.  We discuss the situation daily, but strongly feel that any pricing pressures will be countered by the Fed and as such will bring closer the next US recession not ingrained higher prices. Given that short positions in 10 year US Treasuries are at all-time record highs, there is plenty of scope for a sustained period of increased volatility.  

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