Rising interest rates indicate the market is preparing for increased inflation, the financial markets are adjusting to a new reality characterized by rising interest rates and increased term premiums.
Yesterday, interest rates saw an increase, with the 10-year rate climbing by 2.5 basis points to 4.79%. Similarly, the 30-year rate rose by 2 basis points to 4.97%. Additionally, the spread between the 30-year and 3-month rates has widened by 2 basis points, now at 64 basis points.
Today, we expect the Producer Price Index (PPI) report, which analysts forecast to show another strong reading. The headline increase is projected at 0.4%, consistent with last month, while the core reading is anticipated to rise from 0.2% to 0.3%. Year-on-year, the headline is projected at 3.5%, with the core accelerating to 3.8% from 3.4%.
Expectations for the Consumer Price Index (CPI) report, due on Wednesday, have also risen. Initially forecasted at 0.3% month-over-month, they now suggest a rise of 0.4%. Most analysts anticipate this figure, though it remains subject to change.
Impact of Rising Oil Prices
The market is heavily influenced by inflation concerns, particularly as oil prices increased by 3% yesterday, reaching approximately $79 per barrel. This surge seems to signal a breakout, while RBOB gasoline is also climbing, nearing a breakout level of $2.10.
Rising energy costs are contributing to heightened inflation fears. The two-year inflation swaps increased by more than 4 basis points yesterday, reaching 2.70%, a level not seen since mid-November. The five-year swaps also rose by 4 basis points to 2.61%, approaching the upper end of their one-year range.
Despite media narratives suggesting rates aren't rising due to inflation concerns, the data indicates otherwise. The 10-year breakevens rose by 2 basis points to 2.47%, returning to levels not seen since October 2023.
Inflation expectations and rising term premiums appear to be primary drivers behind increasing rates. The term premium on the 10-year has risen to 65 basis points, one of the highest levels since 2015. These factors indicate the market's demand for higher interest rates to compensate for inflation and long-term risks.
The Federal Reserve has benefited from relatively low oil prices since mid-2022, but the current trends indicate a potential shift. Oil has consistently rebounded from the $65-$70 range, suggesting a higher potential move, despite minor pullback risks.
The upcoming PPI and CPI reports will be critical in shaping inflation expectations and influencing market dynamics. Rising inflation fears and term premiums are clearly driving the increase in interest rates, which will require close monitoring in the coming weeks.
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