• March CPI misses to upside for third consecutive print
• Powell reiterates “higher for longer” narrative
• Agency CMBS spreads widen due to glut of secondary sales

Last week’s Consumer Price Index (CPI) print belabored that the U.S. economy shows little signs of cooling off, as inflationary pressures stubbornly persisted in March. The CPI print was higher than market expectations as inflation continued to uptick; year-over-year Headline CPI print came in at 3.5%, slightly above projections and well above last month’s 3.2% print. The Core CPI level was 3.8%, similarly above projections, but flat to last month’s above-expectations print. These figures mark the third consecutive CPI print to miss above market expectations. A core driver in the recent uptick in inflation is services outside of housing, a sector which includes everything from car insurance to medical care and is closely linked to the labor market. Core services less housing (also known as Supercore CPI) increased by 4.80% year over year in March. Core services less housing accounts for 28% of the total CPI calculation. These elevated inflation levels were paired with another hot print: Retail sales beat market expectations to the upside for the month of March, reinforcing the strength of the U.S. consumer. Market projections for rate cuts in 2024 have cooled significantly. Bloomberg’s projection of the probability of a rate cut in June is down to 16% compared to 53% early last week.

In an interview this week, Fed Chair Jerome Powell noted that it is likely going to take “longer than expected” to gain the confidence needed to lower rates, dashing hopes for more than two cuts in 2024. “This is confirmation that the Fed’s willing to wait it out,” said Diane Swonk, chief economist at KPMG LLP. “There’s concern of how little it took to stimulate the economy, that there’s still a lot of demand.” Similar sentiment has been echoed by Powell’s colleagues at the Fed. Boston Fed President Susan Collins said Thursday she saw less urgency to cut rates than she did just a few months ago because the job market has been stronger than anticipated and because easier financial conditions suggest interest rates might not be slowing the economy as much as thought. “The risks of monetary policy being too tight have receded,” she said. Recent inflation setbacks “also implies that less easing of policy this year than previously thought may be warranted.” The 10-year Treasury rate has sold off more than 40 bps over the month of April as the market reassesses its expectations for rate cuts this year. Bloomberg shows the current market probability of a rate cut in September and December at just over 40%, whereas all other Federal Open Market Committee (FOMC) meetings projected a lower probability. The Fed’s dot plot will not be updated until the June FOMC meeting, so until then, we’re left to read the tea leaves of Fed Speak.

The recent sell-off in treasury rates has been coupled with widening Agency commercial mortgage-backed securities (CMBS) spreads. Spreads had been tightening on an imbalance in the supply of new issuance and the demand for paper, but this dynamic shifted this week. Through the first quarter, Fannie Mae had issued just a little over $10 billion in securities, or about $3.3 billion per month. This issuance is considered new issue (“TBA”) securities and settle over a slightly longer period than those traded in the secondary market, which settle in just a few days. This week, over $3 billion of Agency CMBS sold in the secondary market as end-accounts rotated their holding into MBS, effectively selling in one week the equivalent of one month of new production this year. Due to this glut of supply, spreads have widened four bps over the course of the week for five-, seven-, and 10-year tenors. It’s possible we’ll see more profit-taking in the secondary market cause additional upward pressure, but the widening this week makes it unlikely to see such large lists come through in consecutive weeks.