| Interest Rate Market Snapshot | ||||||
| Federal Funds | SOFR | 2Y Treasury | 5Y Treasury | 7Y Treasury | 10Y Treasury | |
| 4.33% | 4.37% | 4.29% | 4.39% | 4.48% | 4.56% | |
January inflation reinforces a “wait and see” Fed
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Food, Energy, Goods and Services – inflation was everywhere in January
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According to the Consumer Price Index, inflation rose 0.5% last month (higher than the 0.3% median estimate)
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Core inflation surprised as well, coming in at 0.4% in January (also higher than expected)
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In fact, only 5 of the 73 forecasters in the estimate had core inflation rising 0.4%, and nobody called for headline to come in at 0.5%
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Behind the numbers:
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Food: 4 of the 6 major grocery store categories saw higher prices last month. Eggs alone increased 15.2%, the largest price spike since June 2015 and accounted for two thirds of total food inflation
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Energy: Gasoline increased 1.8%, but it was a 6.2% spike in Fuel Oil that contributed the most to the 1.1% overall increase in energy prices last month
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Goods: Apparel got cheaper, but not much else. Used car and truck prices rose last month at the fastest rate since May 2023, while otherwise mundane categories like Prescription Drugs and Books rose at the highest monthly pace in over a decade
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Services: The one bright spot oddly enough was shelter. Owner’s Equivalent Rent maintained December’s 0.3% pace and helped bring the annual change down from 4.8% to 4.6%. In previous reports, it would not be unusual for shelter costs to account for as much as 70% of overall inflation, but today it was just 30%. Elsewhere within services, both car and home insurance costs dominated the inflationary impulses. Car insurance rose 2% last month (highest since May 2022) and home insurance rose 1.1%
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Technically, we did get seasonal factor revisions in this report that may have contributed to these unusually large spikes in the smaller categories, but the details matter little to the rate market at the moment. Higher inflation is higher inflation. Expectations for the next rate cut has been pushed out to December, with the market fully behind the notion that the Fed will remain on hold. Yesterday, Powell maintained the messaging that policy is well positioned for both higher inflation and lower employment, but surely this report will challenge it.
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Leaving floating rate debt unhedged is getting riskier by the day. Tariffs, tax cuts, and immigration policy have yet to fully impact inflation. While government spending cuts and layoffs have yet to fully impact employment. Safest place to be: 50% floating, 50% fixed. Interest rate risk neutral.
Source: Bloomberg
Powell v Trump
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Powell is in day 2 of his annual address to Congress and noted yesterday that:
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“We know that reducing policy restraint too fast or two much could hinder progress on inflation. At the same time, reducing policy restraint too slowly or too little could unduly weaken economic activity and employment”
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“We do not need to be in a hurry to adjust our policy stance”
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Trump doesn’t agree:
Source: X
The fixed rate SOFR market
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Fixed rates from 2 years all the way out to 10 years trade right on top of each other
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So, with 1) a Fed on hold, 2) upside inflation risk, and 3) downside employment risks – try to keep hedging strategies in the 2,3, or 5-year part of the curve
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These rates offer the same savings as longer dated ones while keeping some flexibility in adjusting down the road should you need to
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Outside of the plain vanilla playbook – I’d consider selling a deep out of the money cap to improve the rate even more
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That 5Y rate for example is trading below 4% while the SOFR forward curve bottoms out at 4.10% for the next 10 years
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Source: Bloomberg
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