The bond market reaction to CPI is instructive

The bond market reaction to CPI offers a clue a theme that’s likely to envelop all markets.

US 2-year yields are up 10.7 basis points to 2.92%, breaking the April/May top. That’s a sign of a market that sees a growing likelihood we break the 3% level in Fed funds. In fact, the market is now fully priced in for 3.00% rates at year end, escalating to 3.50% around this time next year.

At the same time, yields at the long end of the curve are lower. US 30-year yields are down 3.6 bps to 3.13% and lower since the CPI report.

Obviously we’re now just a short hop from 2s/30s inverting but the bigger message here is a market that’s worried the Fed will aggressively tighten the economy into recession, leading to a bust in inflation later.

Given 8.6% y/y inflation that’s accelerating at 1% m/m, that’s a tough thought process to argue against. The mounting political pressure on central banks is intense and the only lever they can pull is hiking.

The US dollar is higher on the day, though I think some of this was priced in yesterday. The euro is losing badly as the market finds out that the ECB hiking into a recession and probably a sovereign debt crisis is disastrous for the euro. EUR/USD is down 84 pips to 1.0529.