The March CPI inflation report came out higher than the markets had predicted. The Core CPI report showed a 0.4% increase in March which was higher than the 0.3% consensus prediction in the markets. The annual rate of Core CPI inflation was 3.8% which was above the 3.7% market prediction and flat to last month’s annual rate.
The key driver of this CPI report surprise this morning was the larger than expected increases in gasoline and shelter costs. These two items represented more than half of the total price increases that drove the March monthly inflation number. From the perspective of the Federal Reserve, their view as of this morning is that the economy has been stronger than expected in the first quarter of the year, with strong jobs numbers, unemployment dropping and the Core inflation reports remaining flat after having a nice downward trend for most of 2023.
NOTE that “shelter” is referring to the cost of renting.
Impact to Mortgage Rates. Today’s reports have caused the markets to adjust their projections for the timing and amount of Fed rate cuts this year, moving to the expectation of only two cuts of 25 basis points, with the first cut likely to be by September. This is compared to last week where the markets were projecting the first cut to be likely be June or July, with the possibility of three or more cuts of 25 basis points this year.
As the markets shifted their projections for the timing of the first Fed cut and the total number of cuts this year, these changed projections immediately impacted the bond markets. When the Fed officially announces rate cuts, this normally causes bond prices to rally. Many bond investors have been increasing the amount of bonds they hold in their portfolios in anticipation of a June or July rate cut resulting in nice increases in the value of their portfolio values. As today’s news shifts this date out by several months, this creates incentive for bond investors to sell some of their current bonds, particularly if they worry the Fed could possibly slow their timeline further and do only one or zero cuts this year.
As these bond investors begin to sell their bonds this morning in reaction to this news, this creates more supply of bonds for sale, and this selling side pressure this morning pushes bond prices lower, and this mathematically pushes bond yields higher. This is exactly why bond prices declined this morning and the yield on the 10-year Treasury spiked up.
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