CPI Needs Strong Upside Surprise to Shake Fed, Factors Behind 10-Year Yield Rally

$261 and change. Welcome back to Morning Trade It's time now for the big picture. Let's welcome in Colin Martin head of fixed income research and Strategy, Schwab Center for Financial Research. Colinood morning. Hope you had a wonderful weekend. So it is a heavy day to week. Apoint out. CPIPPIA few other things on the boil. What are you going to be looking for for some directre? Yeah, it's really going to boil down to to the CPI report that's most in focus right now for fed officials. I think that's been a key driver of the moven Treasury yields. Just the outlook for fed policy going forward. S we're going to be paying very close attention th This is something I've been talking about a lot on this program Sam. But I'll I'll repeat i again. What we're focusing most on, I think what fed officials are focusing on are tho monthly core readings. we look at core CPI, the consensus expectation is for a 0.2% core print for the m of September. So that would bege upside surprises right now. We want to see 0.2% or less monthly core readings. And then the b, because we know that's something tha Chair Warsh has been talking about, whether it's the PCE or the C there's still a lot of underlying components that are that are just rising, rising too much. We can look at of various diffusion indexes. And if you look specifically at the CPI, about 60%, just moreans are rising at 3% plus rates on a year over year b That's clearly too high. So we ne see some improvement there as well to be mo confident that inflation is, in fact, moving down towards the Fed's target. Yeah. And think it was John Williams right over at the fed who kind of, I g gave the markets this impression of this sort of useful rule of thumb as far as what they're looking at with that% core month over month. So keeping an eye on that, thend mean for the fed moving forward. Becaus mean you've still got the odds being priced in as you know sub 20% for a this month. But certainly expectations are pretty baked in for that December hike. Yeah. We still expect one hike this year, but probably not December. Expectations have been tempered a lot over the past few weeks, as you alluded to, just, you know, 20% or so implied probability for a hike this month. I think you'd need to see a really probably a big upside surprise to the CPI print to kind of move that fo And for the fed to reactn October. But but you mentioned J Williams. We have been focusing on that. John Williams, as the New York Fed president, is the vice chair of the FOMC. So he's one of the permanent voting members, and he's one of the, you know, attention to in terms of what his v are. So we need to probably s upside surprise because even Williams himself, you know, two weeks ago kind of tempered expectations about the need to aggressively hike in October. So we do expect another rate hike later this year. Sounds seems likely that they'll pause this month. And ae think another hikes likely aslle one hike we saw last month going to d we are seeing these underpressures. We know that there's a lot of supply concerns everything that's going on overseas. But the fed is trying to tamp down demand a little bit. Now we're starting to see the markets do some of the Fed's job for it, especially with the big increase in mortgage rates. But the fed knows the job is not done yet. So we think that they'll they'll hike another two times just to make sure that they do slow demand to aree. And we get more confidentt we can see inflation come down. Okay. Obviously the b markets closed. We're not supposed to talk about the b market, but we will talk about nd market because obviously that's what's been really dri the bus. I mean, obviously fourth year in a bull market, the yields and the oil story still don't seem to have crashed the party just yet. But how are you watching the direction of the ten year? Yeah. Well, we think the idea that the ten year Treasury yield has kind of hovered now above 5% for almost three weeks now, without really disrupting the credit markets or stock market, I think is a good thing. And you know, we we believe we're in you know, higher for longer period right now, but it's mostly just driven to, I think, a strongfun. Right now.al growth is very strong. If you look under the hood of the GDP reports, there's a lot of encouraging signs there. But more importantly, in terms of where could there be cracks? W the higher borrowing costs haven't really flowed through or at least, you know, disrupted the corporations just yet because growth is really strong there. If we look corporate profits, it's not from the Bureau of Economicokina Analysis, which is a much more comprehensive look at sort of the the state and health of U.S. corporations, we're seeing really, really strong corporate profits there as well. So, yes, you know, a 5 or 6% plus borrowing cor corporations, that does matter. But if we're seeing corporate p grow by nearly 9 or more on a quarterly basis and much higherI thin that's why we haven't really seen tooy concerns yet, because companies are just making a lot of money right now, and they can handle these these higher borro costs. I mentioned this a little earlier because ween Emmons on the program last week who ted ou, this strong correlation he's seeing between the ten year and the physical prices rather than the paper prices right now, particularly where some ofhe refiners, which we've been speaking a lot about this morning, are at much more than AI. As far as the rally. Yes. Okay. As Craig pointed out probably not sustainable, but I'm wonderingt you, Colin and the team look at to inform where you see yields heading. Obviously, you say it's been driven by a number oforces. We know that. We know the background behind obviously the factors that a driving that. But I mean if people are starting to look at crack spreads as maybe the key influencere, is that something you're looking at a maybe something yields could start to rea at some point? Well, I think the kind of the prolonged period of elevated energy prices right now is certainly something that we're paying attention t we're still seeing that coion right now. You know, we're still near $100 or so per barrel for oil. That's certainly not a good thing. You know what we're focusing on though? Well, any upside surprise if we see an escalation and we start to see oil prices rise for whatever reason, that would likely pull up long term yields as well. But we're also focusing on the downside, knowing that there could be demand destruction if we're seeing higher gas prices for us as consumers at the pump, does that start to take take away money, especially in the environment we're in right now, where economic growth is strong, consumption is strong, but weeing a declining savings rate. So howong can we can we continue to do this as consumers in aggregate? If we're seeing, you know, prices at the pump siphon money away from where we could be spending elsewhere.o it's kind of two sided right now. But I think if we do see anation and we see energy prices rise, I do think that pull up long term treasury yields, at least for now. Okay. Something to watch Colin really appreciate Have a great wmuch for tha