Producer Level Inflation Weak. Bonds Rally Overnight

By: Matthew Graham

This morning's most significant data, October PPI, printed at +0.4%, weaker than the +0.8% expectation.  Considering the railing bonds have taken of late, any validation of the ABSENCE OF inflation is a good thing.

Reuters Quick Recap...

+0.4 PCT (CONSENSUS +0.8 PCT), VS SEPT +0.4 PCT

EXFOOD/ENERGY -0.6 PCT, LARGEST DROP SINCE JULY 2006, (CONS +0.1 PCT) VS SEPT +0.1 PCT

YEAR-OVER-YEAR PPI +4.3 PCT (CONS +4.6 PCT), CORE +1.5 PCT (CONS +2.1 PCT)

INTERMEDIATE GOODS +1.2 PCT, EXFOOD/ENERGY +0.6 PCT

RUDE GOODS +4.3 PCT, EXFOOD/ENERGY +2.1 PCT

ENERGY +3.7 PCT, GASOLINE +9.8 PCT, HEATING OIL +5.1 PCT

FOOD -0.1 PCT, TOBACCO UNCH, PASSENGER CARS -3.0 PCT, LIGHT TRUCKS -4.3 PCT

But interestingly enough, a majority of this AM's gains in the bond market came BEFORE PPI.  It's as if the market traded a tame PPI ahead of the tape and the report itself just confirmed that bias. 

It's even more evident in the treasury chart below that 8am sharp saw yields significantly lower, 30 minutes ahead of data.  Take note of the red line as well, a very simple internal trendline along yesterday's AM high yields and this morning's low yields.  We can watch to see if this offers any further resistance and assign significance accordingly.

If you're thinking that the bond markets SHOULD be reacting more positively to a weak PPI print, you're probably right in a historical context.  But just like bonds were reluctant to track stocks yesterday, so too will you likely notice at least a moderate disconnection from econ data for the time being, at least until knives and shoes and balls drop.  In other words, it seems that everyone knows what's SUPPOSED TO BE happening in the bond market right now, but we're waiting for the game to officially begin. 

Sadly though, some WON'T wait before "calling the game."  You'll read and/or hear more than a few people saying something to the effect of "the Fed's QE2 efforts are having an OPPOSITE effect!!"  Front page of the journal this AM (yeah... I still get the paper version) has a more or less appropriate take on the matter, paying just enough attention to the paradox of rising rates despite QE2, but thankfully being sure to say "it's far to early to declare the Fed's plan is failing." 

There's an interesting series of statements in the article which I think could easily be made by many market-watchers.  In one breath, we have this sense that "QE2 SHOULD BE HELPING RATES AND IT'S NOT."  But in another breath, it's common understanding to say the promise of QE2 caused rates to fall.  So where's the reality?  Take QE2 out of the equation... Where would rates be? 

Here's the bottom line: If we see big market movements chalked up to an impending event, BOTH THE TIME BEFORE AND AFTER THE EVENT MUST BE CONSIDERED IN DETERMINING WHAT EFFECT THE EVENT HAD ON THE MARKETS!!!!

Make sense?  Sure, some could say "QE2 happened and rates went up," but they would be wrong.  QE2 began happening when traders began packing on the new longs that were unwound yesterday...  The actual injection of the capital or transactions of securities are relatively insignificant in the trader's world...  Trade or Fade the expectation, adjust accordingly for reality.  That's all this is folks, and the beautiful (and hopefully not ugly) thing is, that the transactional phase of QE2 is really in it's infancy.  Smart people agree it should have a salubrious effect on rates, and like us, are just waiting for the bleeding to stop.

The only debate on the horizon that scares me is over the malleability of the plan, in that there is speculation that the program could end early or to phrase it more bullishly, "not be extended."  In my view, it is really this uncertainty over "how long and how much" that does the most damage and is causing the most "false starts" as we all wait for the real game to start.