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The Price is Wrong

May 17, 2021

Last Week in Review: The Price is Wrong

This past week, the yield on the 10-year note increased to its highest level in one month in response to a very hot consumer inflation reading. Let us break down what happened and get into what to look for in the week ahead.

Last Wednesday, the financial markets were prepared for a high Consumer Price Index (CPI) inflation reading. Well, the report showed headline consumer prices climbed 4.2% year-over-year, far above the 3.6% expected and the Core CPI (which strips out food and energy) rose by 3.0% year-over-year, the largest 12-month increase in 26 years.

The market reaction was a swift decline in both stock and bond prices with yields moving higher. If inflation rises, rates/yields must rise to compensate the investor for the effects of inflation.

Some bad history was made with this spike in inflation. For the first time in nearly 50 years, CPI has exceeded mortgage rates on a year-over-year basis. This screams opportunity for those looking to refinance or purchase a home, because at some point either inflation must come back down, rates must go up, or some combination of both.

Will Price Increases Be “Transitory?”

That is the biggest question for the economy and financial markets. The Federal Reserve fully believes that the spike in prices will be temporary, and we should see a moderation in prices come fall. So we will have to wait to see if the Fed is correct. What we can expect over the summer months is more volatility in stocks, bonds, and rates, as future inflation readings will be closely watched for sustained and substantial price increases.

“Don’t Fight the Fed”

We should all remember that saying. The Fed continues to hold the Fed Funds Rate near zero and purchase bonds to keep long-term rates low. The muted outlook for inflation supports their stance.

If the Fed is right and inflation does moderate in the fall, we will not see any major increase in rates. If the Fed is wrong and we see sustained higher inflation, the Fed will likely adopt other tools to help keep long-term rates low. Again, likely no major increase in rates.

If that sounds a bit like a win-win from a rate perspective, yes, it is. We should expect rates to remain relatively low for a longer timeframe.

Bottom line: This is no time to get complacent, and while interest rates may not move too high in the near future, they may also not improve much from here, as evidenced by what happened last week. Take advantage of what is available today thanks to the Fed bond purchasing program.

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