Mel's Blog

Inflation at the wholesale or producer level was reported far hotter than expectations with the Producer Price Index (PPI) coming in at 1.3% versus expectations of just 0.5%.  And the Core PPI, which strips out volatile food and energy, was reported at 0.4%, which was also higher than the 0.2% expected.  Producer Prices have increased 2.5% over the past 12 months, reaching their largest year-over-year gain since last August, while the Core Prices are up 1.8% in the past 12 months, matching January's year-over-year increase.  

The key here is whether higher PPI, or higher wholesale inflation will pass through to consumers and result in a higher Consumer Price Index (CPI) Report tomorrow.  Producers or wholesale manufacturers can see their costs to produce products increase, but not have the power to pass them on to consumers in a competitive marketplace.  The result is that the producers earn a little less, but consumer inflation - the key measure for the Fed - remains favorable.  It will be interesting to see how this plays out tomorrow, when we will get the results of the CPI Report.  

Mortgage Bonds did not move much lower on this inflationary data because of a very weak NY Empire State Index.  The index was reported at a sloppy 1.9 reading in March which was far lower than expectations and the lowest reading since May of 2005.

Initial Jobless Claims were reported at 318,000, which showed improvement and were better than expected.  The four week average, which gives a better overall trend, also improved.  So labor remains healthy. 

The Philadelphia Fed Index will be released at Noon ET and it could be a market mover if the reading is significantly out of line.  

Stocks are looking a little stronger this morning after shrugging off the inflationary news and weaker than expected economic data.  Yesterday, stocks made a big reversal off the lows and each of the major stock indices have favorable looking chart patterns.  Should stocks continue to grind higher, it may be at the expense of Bonds and prices may worsen.

When you factor in the chance of a hot CPI tomorrow on the heels of a hot PPI , the overbought state of bond prices, tough overhead resistance, as well as a stock market that is attempting to reverse higher from a sell-off, it appears prudent and conservative to lock today in advance of tomorrow's CPI Report. 

As we mentioned yesterday, the overbought state doesn't necessarily mean that Bonds are going to move lower, but if they start to move lower on a hot inflation reading tomorrow, the price erosion could be exaggerated.  Additionally, if the number comes in weaker than expected, the Bond's upside move will likely be somewhat muted.