Consumer Inflation at 40-Year High

John Smith
January 1, 2023
5 min read

Consumer inflation reached a 40-year high and Fed members made headlines in response. Jobless Claims continue to move in the right direction.

Consumer Inflation Reaches 40-year High

The Consumer Price Index (CPI), which measures inflation on the consumer level, rose by 0.6% in January. This was hotter than expectations and pushed the year over year reading higher from 7% to 7.5% – the hottest level since 1982!

Note that annual inflation is calculated on a rolling 12-month basis, meaning that the total of the past 12 monthly inflation readings will give us the year over year rate of inflation. Each month, the most recent report replaces the oldest monthly reading.

The rise in inflation we have seen is due in part to the readings throughout 2021 replacing the low inflation readings from 2020 when much of the economy was shut down due to the pandemic. Last week, the 0.6% increase reported for January 2022 replaced the 0.2% rise previously reported for January 2021, causing the annual reading to rise.

Core CPI, which strips out volatile food and energy prices, also came in above expectations with a 0.6% rise. As a result, year over year Core CPI jumped from 5.4% to 6%.

Within the report, rents rose 0.5% in January and increased from 3.3% to 3.8% on a year over year basis. While this data has started to increase, the CPI report is still not capturing the double digit increases year over year that many other rent reports are showing.

Owners’ equivalent rent increased 0.4% and the year over year figure rose from 3.8% to 4.1%. However, note that this data is based on a survey that asks homeowners, “If someone were to rent your home today, how much do you think it would rent for monthly, unfurnished and without utilities?” Understandably, this is very subjective and many people would be guessing how much their home would rent for.

Remember, inflation is the arch enemy of fixed investments like Mortgage Bonds because it erodes the buying power of a Bond's fixed rate of return. If inflation is rising, investors demand a rate of return to combat the faster pace of erosion due to inflation, causing interest rates to rise.

On a related note, the National Federation of Independent Business released important data that speaks to how inflation is impacting small businesses. The Small Business Optimism Index fell to 97.1 in January, which is the weakest since February 2021. Within the report, plans for higher selling prices rose another 4 points to the highest level since 1974. Compensation costs rose another 2 points to 50, which is the highest since 1984 when the question was first asked. Both of these figures reflect the rise in inflation.

Fed Members Making Headlines

Rising inflation is a big reason why the Fed’s actions remain crucial to monitor in the months to come, as they will play an important role in the direction of the markets and mortgage rates this year.

Note that the Fed has two levers they can pull for tightening the economy – hiking their benchmark Fed Funds Rate and reducing their balance sheet. The Fed Funds Rate is the interest rate for overnight borrowing for banks and it is not the same as mortgage rates.

Hiking the Fed Funds Rate will actually be a good thing for mortgage rates, as the Fed curbs inflation and preserves the fixed return a longer data Bond provides. However, reducing their balance sheet (which means allowing Bonds to fall off their balance sheet and no longer reinvesting in them each month) would cause more supply on the market that has to be absorbed. This can cause mortgage rates to move higher.

After the CPI report was released on Thursday, St. Louis Fed President Jim Bullard made some hawkish comments, saying that he wants to see 100bps of hikes by July 1, which would imply that we would need to see one 50bp hike and two 25bp hikes at the next three meetings.

Probably the biggest thing he said was that he thinks the Fed should be able to act and hike rates in between meetings. This was a new concept that shows just how serious he is about fighting inflation and removing accommodation.

Stocks sold off on the news, but so did Bonds. You may have thought that Mortgage Bonds would have responded better to the Fed being more serious about hiking rates and curbing inflation, but it also may mean that the Fed will more aggressively reduce their balance sheet, which Mortgage Bonds do not like. Some Fed members of late have made comments that the Fed should be selling Mortgage Bonds to reduce their balance sheet and holding onto their Treasuries.

It's important to note that Bullard does make outlandish comments oftentimes and he is only one voting member. It does not mean that all the Fed members echo his thoughts. And on that note, we also heard from San Francisco Fed President Mary Daly last Thursday, and she said she is not on board with a 50bp hike and would rather see a 25bp hike. She is concerned with the Fed being too aggressive and thinks they need to move at a goldilocks pace.

Additionally, Richmond Fed President Tom Barkin said that while he is open to a 50bp hike, he does not think that the markets are screaming for one and would rather a 25bp hike. And we heard from Atlanta Fed President Raphael Bostic earlier in the week who said he supports a 25bp hike but that anything is on the table.

The bottom line is that we will want to closely watch how the Fed tries to walk the tightrope of hiking and allowing a balance sheet runoff during 2022.

Initial Jobless Claims Decline

Jobless Claims Week Ending 2/5/22

The number of people filing for unemployment benefits for the first time fell by 16,000 in the latest week, with Initial Jobless Claims reported at 223,000.

After the rise in jobless claims in the first part of January, which was likely due to the rise in Omicron cases, claims are now falling once again as Omicron cases are slowing down.

Continuing Claims, which measure people who continue to receive benefits after their initial claim is filed, were unchanged at 1.62 million.

There are now 2.099 million people in total receiving benefits, and while this is an increase from 2.067 million in the prior week, it is a stark contrast to the 20 million people receiving benefits in the comparable week the previous year. Claims are at very strong pre-pandemic levels, showing that the labor market remains tight.

Strong Auction Demand Doesn’t Benefit Bonds

Investors were closely watching Wednesday's 10-year Treasury Note auction and Thursday’s 30-year Bond auction to see the level of demand. High demand, which is reflected in the purchasing of Bonds and Treasuries, can push prices higher and yields or rates lower.

Weak demand, on the other hand, can signal that investors think yields will continue to move higher, which can have a negative effect on rates.

The 10-Year Treasury Note auction was met with strong demand as traders took advantage of some of the highest yields in more than two years. The bid to cover of 2.68 was better than the one-year average of 2.47. Direct and indirect bidders took 92.6% of the auction compared to 83.1% in the previous 12. However, we did not have the positive reaction we would expect in yields.

Thursday’s 30-Year Bond auction was met with average demand. The bid to cover of 2.30 was just above the one-year average of 2.29. Direct and indirect bidders took 84.8% of the auction compared to 81.1% in the previous 12.

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