Paradoxical Bond Bounce Despite Hotter Inflation Data

Abstract

We knew CPI was the biggest potential market mover this week and it hasn't disappointed in that regard. Truth be told, the initial sell-off was surprisingly tame given the 1.3 vs 1.1 CPI headline. As for "Why," that is a matter of speculation, but the word on the street is that traders are still thinking today's report represents peak inflation. Today's report does little to change the already-priced-in 75bp rate hike seen from the Fed in 2 weeks, and it added roughly an additional quarter point of rate hikes to the end-of-year outlook. It represents the expected Fed Funds rate after the June 2023 Fed meeting. Note that it was already lower than the December 2022 level and that it dropped significantly faster during today's correction. This is essentially the market's way of saying "Yeah, we see that hotter inflation in today's numbers likely means another 25bps for the Fed, but we still think they'll be forced to cut rates in 2023." As for WHY, that's as simple as the growing chorus calling for recession and the ongoing decline in commodities prices that theoretically results in lower inflation at some point.