Wednesday's Market Minute: Why Soft CPI Could Bring Higher Yields

The most notable event in the market the past week is the shocking revelation that investors are, in fact, capable of selling Treasury bonds still. The 10-year yield is steadily inching its way higher after making what looks like a short-term double bottom just above 1.1%. Now at 1.34%, the yield is about the highest in a month.

At the same time, cyclical companies are on the up, and even some epicenter stocks like cruise lines are trying to rally. Washington’s infrastructure deal is probably helping, but last week’s payrolls report was also just about perfect: more jobs added than expected, and wage growth right in line with expectations, which means no worrisome inference about employment’s impact on inflation. But today, we get the actual inflation print, and last time the monthly change was less transitory than economists expected.

If we get another warm print, are yields finally primed to wake up and take off again?

That’s the most important question investors should be asking right now, and the answer may be murkier than many think. Last month’s hot CPI led to a one-day bounce in the 10-year, but immediately reversed by the end of the week and the yield curve continued its downward trend that began in late spring. Delta’s spread has been lingering over the market recently and some growth expectations have been dialed down, but the vexing truth is that long-term bond yields have collapsed as the inflation trend’s gotten hotter than economists expected.

The best way to understand why is to accept the framework that as inflation gets hotter, it increases the odds that the Federal Reserve will unwind monetary support. It’s not some twisted logic – check the history book: yields declined in past tapering periods by the Fed. From there, it’s easy to see why yields have dropped so much as inflation data’s beat expectations: bond traders are front running the historical decline in yields that happens when support is withdrawn from the market. Another, simpler way to see it: the hawkish June FOMC is what kicked off the flattening in earnest.

COVID concerns and the insatiable global thirst for the yield are secondary to this undercover taper positioning.

Wednesday’s CPI print gives us a chance to see just how much hawkish potential has been baked into the market at this point. If the number does nothing to move the Fed’s taper timeline forward, yields should be in the clear to extend their climb, as it means the economy is more likely to go about its recovery without hasty interference from the Fed. If the recent awakening of bond bears is any sign, maybe it’s already enough. That means anything other than a red-hot CPI should be good for some bond selling.

Catch is, if that happens, it also confirms the above framework, and that means bonds have spent five months preparing for a faster taper timeline. Do stocks look like they’ve done the same?

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