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September 9, 1994
The worst wholesale price inflation report in four years has mortgage rates headed up towards nine percent, and maybe higher.
The Producer Price Index rose .6%, and the "core" rate without energy and food components rose .4%. Markets had expected a rise in these prices, but the actual figure nearly doubled many forecasts.
The usual, reassuring analysis of a troublesome inflation report won't work this time. There was no "single market" aberration which could explain away the high number: the .4% core rate extended across all wholesale goods.
There are some soothing thoughts.
First, the safety in numbers theory: one report does not constitute a trend. Also, inflation tends to lag economic growth, and this bad report may be the last gasp from an already slowing economy. And, other wholesale price rises have had little retail follow-through, so maybe Tuesday's consumer price index release will be okay.
If Tuesday's CPI is not okay, and shows a core rise in .4% territory, bonds and mortgages are at immediate risk to blow out the top of the nice, polite, and secure April-September trading range.
The markets and the Fed are right at the edge of a replay of February and March. You may recall that the Fed began its first, tentative tightening in February, saying it intended to "pre-empt" the possibility of too much growth leading to inflation.
In February and March, wary long term investors dumped bonds and mortgages so hard that yields rose almost two full percent -- double the magnitude of the Fed tightening at the time. The Fed has gradually tightened since, taking Fed funds up the same 1.75% which the bond market had more quickly arranged on its own.
Fed funds are now 4.75%, a reasonably tight level if you think inflation is no higher than 2.50%-3.00%. However, if inflation has crept to 4.00%-plus territory, the Fed is a percent or two late, and not pre-empting anything, just following. Sustained monthly core rates at .3% and .4% annualize at over 4.00%.
To protect its own interests, the bond market may be about to take measures into its own hands, again, and in the ungraceful, ungradual way that markets tend to work.
Lest these worries end on a grim note, take heart in the protection offered by the April-September trading range. It has been so persistent and so well-defined that it will take a financial earthquake to break it down.
The first chance for the tremor is CPI Tuesday, and there won't be another until the next set of jobs data in early October.
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