News & Analysis

After the recent rally in front-end Treasury yields and money market expectations for the Fed’s near-term policy path, the focus for financial markets quickly shifted to the back end of the Treasury curve.

This wasn’t solely due to the Fed divulging information about their plans for quantitative tightening, which will predominantly affect the back-end of the curve due to a higher concentration of purchases in longer-dated securities, but also a slight reassessment by markets in the Fed’s terminal rate. While price action has somewhat settled at the front-end of the curve, opinions tend to differ to a greater extent on the Fed’s ultimate terminal rate. Today’s CPI release for March won’t help end the current debate, as the report offered ammunition for both sides.

On the one hand, core inflation moderated in March with a sequential slowdown from 0.5% MoM to 0.3%, while on the other hand, headline inflation exceeded expectations at the margin. Headline inflation rose 1.2% MoM in line with expectations, while the annualised rate exceeded expectations by 0.1pp to print at 8.5%.

The slowdown in core CPI MoM to the lowest reading since September 2021 suggests that domestic inflation conditions are starting to cool, thus warranting a more moderate Fed reaction over the course of the tightening cycle. Meanwhile, the rise in headline CPI to levels last seen in May 1981 threatens a further de-anchoring of inflation expectations, and thus a more aggressive stance from the Fed to contain the risks of current inflation manifesting more persistent, above-target inflation over the medium-term. The market reaction to today’s data suggests that the former argument was more pertinent for market participants. However, it is unlikely that markets will completely settle on the idea of a more moderate tightening cycle from just one piece of data.

Inflationary impulse is relatively negligible after stripping out energy and food

In response to the release, the broad US dollar index, DXY, weakened by 0.33% after the announcement, while the US 10Y yield dropped 5.4bps from 2.76% to 2.71% .

That lowered the market 10Y breakeven rate of inflation from 2.93% to 2.90%. That metric, which signals the degree of future inflation expected by the Treasury market, currently sits near highs last seen during the midst of the Ukraine war when the inflation shock was more prominent for markets.

Lower core print drives DXY and US 10Y yield lower as headline bump is fuelled by energy

Within the CPI basket for March, energy and food provided the biggest month-on-month increase at 1% and 18.1% respectively.

Specifically within the energy bracket, gasoline, which rose by 18.3% in March, supplied 63% of the increase in headline CPI on a monthly basis. Given the concentration of the inflation pressures—as highlighted on a top-line basis in the divergence of headline CPI and core measures and the response by the Biden administration to release a record amount of barrels from the Strategic Petroleum Reserve to bring domestic energy prices down—today’s CPI measure is easily argued away by those calling for a more contained reaction by the Fed beyond the next few meetings. When looking at metrics that are sensitive to domestic demand, such as apparel and core services, the inflation pressures are much more moderate at just 0.6%. Comparatively, previous sources of “transitory” inflation, aka used car prices, are now starting to add deflationary pressures.



Simon Harvey, Head of FX Analysis
Jay Zhao-Murray, FX Market Analyst


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