Yesterday, Treasuries sold off abruptly on a report suggesting that the consumer, despite many headwinds, has not stopped spending. April retail sales were -2% month over month matching consensus expectations. However, retail sales excluding autos came in at +0.5 %, which was more than twice market expectations of +0.2%.
In addition to the stronger retail data, the market was unnerved by two Federal Reserve Presidents (Jeffrey Lacker and Sandra Pianalto), who both expressed significant concerns about rising inflation and its effect on the overall economy. Mr. Lacker stated that, "The Federal Reserve is responsible for keeping total inflation low and stable—including food and energy prices." Ms. Pianalto suggested that prices are rising somewhat faster than preferred and remains the biggest risk to the economy. Inflation concerns were also raised by UK and ECB policy makers who stated that monetary policy is on hold due to rising inflationary pressures.
On the day, Treasury yields rose dramatically with 2 and 5 year benchmark yields rising by 15 basis points, whereas the longer end sold off by 10 basis points. The curve continued its recent bear flattening as the 2-10 year spread narrowed to 145 basis points.
In the credit markets fixed swap spreads widened due to comments from Fed Chairman Bernanke that the credit markets, while improving, remain unsettled, fears that LIBOR has been artificially understated, and renewed concerns over MBIA’s/AMBAC’s ability to maintain a AAA rating. Wider swap spreads led to wider credit spreads across agency paper and MBS.
Given the recent inflation rhetoric from the Fed, the market will pay close attention to today’s release of April CPI data. The consensus expectation is for April headline CPI to come in at 0.3% whereas core—excluding food and energy—are projected at 0.2%. Any significant deviation from expectations is likely to lead to large moves in rate and the shape of the curve.
