Morning Report: Breakeven inflation rate hits a record high

Vital Statistics:

S&P futures4,536-5.2
Oil (WTI)83.310.89
10 year government bond yield 1.69%
30 year fixed rate mortgage 3.27%

Stocks are higher this morning after troubled Chinese property developer Evergrande made an interest payment last night ahead of the default deadline. Bonds and MBS are up.

Globally, we are seeing improved sentiment based on the Evergrande situation, however manufacturing activity in Europe is down to an 8 month low as shortages are clogging up the system. European manufacturers are able to pass along price increases relatively easily, so you have falling GDP and rising inflation. The German Bund yield is trading at a 2.5 year high of negative 9 basis points, which is part of a global move higher in yields.

Existing home sales rebounded 7% MOM in September, according to NAR. This was still down a couple of percent on a YOY basis however. “Some improvement in supply during prior months helped nudge up sales in September,” said Lawrence Yun, NAR’s chief economist. “Housing demand remains strong as buyers likely want to secure a home before mortgage rates increase even further next year.”

Depleted inventory remains the biggest issue for the housing market and is largely responsible for the upward pressure in prices. Inventory fell 13% YOY to 1.27 million units, which represents a 2.4 month supply at the current sales pace. A balanced market is generally considered to be around 6 month’s worth. The average home sold in just 17 days.

The median home price rose 13% to $352,800, and all-cash sales accounted for 23% of transactions. First time homebuyers are being squeezed by professional investors and institutional money which is flooding into the residential rental space. With cap rates around the mid single-digits and double digit home price appreciation, the returns in this strategy dwarf every other asset out there.

Yesterday’s Treasury Inflation Protected Securities (TIPS) auction was strong, and is useful as a market-driven look at inflationary expectations. The way these work is the face value of the bond increases by the Consumer Price Index during the life of the bond. You can therefore compare it to a corresponding Treasury and calculate the expectations for inflation going forward. This is called the “breakeven” inflation rate, which means if inflation rises above the breakeven rate, you are better off in the TIPS bond. If it doesn’t you are better off in the Treasury.

If you take a look at yesterday’s auction, the breakeven inflation rate rose to 2.94% for the next 5 years. This is pretty much an all-time record. Note TIPS are a relatively new security and weren’t around during the high inflation 70s and 80s.


Author: Brent Nyitray

In the physical sciences, knowledge is cumulative. In the financial markets, it is cyclical

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