Today’s Consumer Price Index (CPI) report came in cooler than expected today – and rates fell sharply as a result.
This is because the bond market and interest rates are hypersensitive to inflation reports.
Does this mean we’re saved, and we can expect inflation and rates to continue to fall?
In a word – nope!
Rates have been climbing quickly and to surprisingly high levels in recent months for a few reasons:
- Bond investors expect continued economic growth under Trump.
- Bond investors believe inflation is NOT contained and that the Fed cut too soon and too much.
And/or
- Bond investors are very concerned about increased government spending – particularly over the last month or two as the Biden administration has started to push funds out the door at record levels before they leave the same door.
This can both (a) foster more inflation; and/or (b) saddle the government with such higher borrowing needs that rates will have to increase to bring enough bond buyers to the table.
Causes of Inflation
The primary cause of long-term structural inflation is an increase in M2 Money Supply (checking, savings, money market accounts, cash on hand).
Increased prices, though, can be caused by higher demand, supply shocks (like we saw in the 1970s with oil embargos or during COVID with lockdowns), and an increase in input costs (like when oil prices increase).
The primary source of more M2 money is bank lending, as I have explained many times. Banks literally create money out of thin air when they lend it to people and businesses.
And right now, bank lending is not increasing at rates high enough to spike the M2 money supply, and the M2 money supply is still lower than it’s 2022 peak.
Oil Prices Spiking
Oil prices have recently surged to $78 per barrel, after falling to $65 per barrel in September. These higher energy prices will likely work their way into CPI too, and that will scare the bejeebers out of the bond market.
BUT, as Jeff Snider points out, consumers are forced to buy energy (heat, gas, etc.), and that, in turn, forces them to spend less on other items – which will result in less demand and lower prices for many goods – eventually.
That, in turn, could even foster a recession, resulting in layoffs, even less demand, and less bank lending (like we saw in the 1970s).
Main Point: Inflation and Rates Can Still Fall – But Not in a Straight Line
The points I make in today’s blog and today’s drop in rates are perfect illustrations of the reminder that rates never move in a straight line.
It’s also a reminder of how many variables influence CPI and inflation in general.
CPI Was 5.6% in July of 2008! (Compared to 2.9% Today)
Last but not least, I again want to remind readers that CPI hit a whopping 5.6% in 2008, shortly before we saw deflation.
So, today’s 2.9% reading is still relatively mild compared to 2008.
My point: We can still expect variances and sharp rate movements up and down – before rates ultimately fall.
