Mortgage and U.S. government bonds rallied Friday morning reacting to softer than expected retail sales combined with an anemic Consumer Price Index inflation reading.
Regarding the CPI readings, the Core CPI reading (which removes food and energy due to their volatility) came in at a meager 0.1%. This reading was well beneath expectations of 0.2%. This left the year-over-year CPI at 1.7%, well below the 2.00%-plus that the Federal Reserve would like to see on CPI. The Fed also closely analyzes the Personal Consumption Expenditure (PCE), which is also trending well below the Fed’s target inflation rate.
While the Fed continues to believe low inflation readings are transitory, ongoing low inflation readings are a strong sign that interest rates will remain low for the near term. While many economists believe a December rate hike of .25% is still on the table, the Fed’s reason for raising rates has more to do with rising asset prices and high valuations on some types of real estate. After 10 years of low interest rates, the Fed would like to move the short terms interest rates back to historically normal levels. A return to normalcy does make sense given the strong jobs market, stable inflation, and all-time highs in U.S. equities.
Given the weak inflation data, we are biased toward floating interest rates, but we advise to be very cautious in doing so.