Current position: Carefully Floating
Stocks and mortgage bonds are both higher to start the day. It's a quiet economic news day but a busy week, highlighted by inflation data tomorrow morning.
Week Ahead
Tuesday: Consumer Price Index, NFIB Small Business Optimism Index
Wednesday: Mortgage Apps, Retail Sales, NAHB Housing Market Index
Thursday: Producer Price Index, Housing Starts, Initial Jobless Claims
CPI
We are anticipating the inflation report to show a little progress, but not as much as previously thought. The BLS (Bureau of Labor Statistics), which puts out the Jobs Report, also puts out the Consumer Price Index report. We have covered the changes in the jobs report and substantial revisions/adjustments, and there were some made to the CPI as well.
Some of the figures from last year were revised lower in the earlier months and higher in the later months, which changes some of the replacement figures.
The last reading, for December, showed core inflation at 5.7%. The market was originally expecting a drop to 5.4%, but after some of these revisions and quirks within the report, it is only anticipating a drop to 5.5%.
There is an adjustment with insurance plans and Medicare that occurs in January, which could provide a 0.1% bump. Additionally, we did see a jump in used car prices and gas prices in January. Taking this all into account, we think that we will see a little improvement in core CPI, but not significant. The question is how the market will react—will the market like the fact that we see progress or be disappointed with less progress than initially thought?
Core drop from 5.7% to 5.5%
Money Supply Shrinking
The definition of inflation is too many dollars chasing too few goods, so clearly the money supply is an important component.
A very common measure of the money supply is M2, which includes cash, checking deposits, and other types of deposits that are readily convertible to cash, such as CDs. But our good friend Lacy Hunt believes ODL (other deposit liabilities) is an even better measure. It makes up about 80% of the M2 measure and eliminates cash and retail money market funds. Cash is being accepted at an increasingly smaller number of places and is not used for big purchases. And retail money market funds were never a real medium of exchange. ODL really looks at the "energizing" component of the money supply, which decreased by 1.8% last year—the first decline on record.
We saw a big increase in the money supply, well above the longer-term trend, during 2020 and 2021 as the Fed printed money. But with the Fed tightening, they are now vacuuming up that excess, and based on the trajectory, it appears that by the summer most of the excess will be removed.
This means that we will likely continue to see the money supply and inflation decrease, especially around mid-year. Of course, that translates to lower mortgage rates and lines up with our thoughts about May 10 being a great day in the bond market.
Technical Analysis
Mortgage Bonds have gotten back above the important 100-day moving average and have room to move higher until reaching resistance at 100.758. After locking on Thursday and Friday, with support at the 100-day holding, and with the hope that we see a little bit of improvement on the inflation front tomorrow, we can begin the week carefully floating.