MBS Live Day Ahead: Yes, Inflation Data Matters Now

After a longstanding reign as one of the most meaningful market movers, inflation data became an outcast for most of the recovery from the financial crisis.  Old dog market watchers probably scoffed in 2011-2015 when I said that "no one cared" about inflation data.  But like so many other potential motivators, market participants have an unfortunate tendency to ignore more recent track records if something "has always" been a certain way in the past.

In other words, the old dogs had a very hard time letting go of inflation as a key market mover. The following snippet from July 2013 helps set the stage for the current discussion:

"For the better part of 3 years, markets have had almost zero concern for inflation data. It used to be that CPI and PPI (the "price index" reports) would have a noticeable, logical effect on trading levels in bond markets. But at least since mid 2011 (and arguably even before that), concerns about too little inflation resoundingly trumped concerns about too much. And "too little" inflation isn't the sort of concern that US traders are accustomed to trading, so markets did nothing with it." 

July, of course, was the start of the taper tantrum, and it was the first time that markets had the unpleasant task of trying to make sense of the Fed removing accommodation despite a steady decline in core inflation since the beginning of 2012.  But after inflation leveled-off (and even bounced back a bit), market participants began to wonder if it was actually possible that we were seeing some traction.  Here we have the Fed hiking rates (sorta), not buying new bonds, talking about tapering reinvestments, and inflation was still holding around 2%.  Well, it was until May 2017.  

Since then, core annual CPI has fallen under 2%.  The Fed says it could take years before sustainably getting back above that target.  And in general, it's inflation more than anything else that will make or break the Fed's case for continuing to remove accommodation.  As such, it's no surprise to see the CPI data behind the biggest market movement of the past 2 months (biggest intraday trading ranges) and one of the biggest days of the month in May.

If today beats/misses big, things should get interesting.