Authored by Michael Lebowitz via RealInvestmentAdvice.com,
Imagine someone looking into their crystal ball and telling you at the beginning of October that the coming September CPI data would be higher than expected, and producer prices (PPI) would rise 1.3% for the month, well above the 0.5% forecast. On top of the bad inflation news, they also said more inflation pressure was brewing, with crude oil prices rising $10 through the first two weeks of the month. Based on that foresight, where would you guess the 10-year Treasury yield would be? To help you answer, the ten-year US Treasury yield was flirting with 5.25% on October 1. We bet most professional bond traders would have bet on 5.50% or even higher.
On October 14th, the 10-year Treasury yield surged after the CPI report, hitting 5.33% minutes after the release. A few days later, it was markedly lower at 5.03%. The 30-year yield fell by a similar amount. Bonds rallied into the teeth of the bad inflation data.
Mohamed El-Erian, ex CEO of PIMCO and renowned bond expert, asked the obvious question on X:
Why are US government bond yields falling despite hotter-than-expected CPI and PPI inflation prints?
He offered two valid rationalizations. In this article, we walk through his two AI-related explanations and add two of our own. Importantly, we emphasize one we think matters most: the bond market may be starting to price in the risk that the Fed is being pushed into a policy mistake.
