Trading Desk Talk

Bye, Bye, Miss American Pie

After a February with investors in a “buy, buy” mood, the first half of March has had more of a “bye, bye” tone (Figure 1). The catalyst for the sell-off is a mix of fears of upward inflationary pressures, along with war-related budget woes that will increase Treasury supply down the road. Don McLean may therefore have said it best when he sang “February made me shiver, with every paper I’d deliver [presumably agency/FHA origination], bad news on the doorstep, I couldn’t take one more step … So, bye, bye, Miss American Pie.”

The war with Iran is difficult to predict for its duration, its magnitude, and, ultimately, its market effects. We touched on some of the inflationary aspects of the war, specifically for oil, last week. Here, we dive deeper into the broader Consumer Price Index (CPI) and Personal Consumption Expenditures (PCE) reports released last week.

Energy costs have largely been benign since the post-pandemic recovery, when demand stoked energy’s contribution (orange chart in Figure 2) to the headline CPI number. (Per last week’s Talking Points, the energy weight is only 6.3% of CPI.) Figure 2 shows monthly inflation in the four main components of the CPI since 2021.

Food, weighing in at 13.65% of the CPI, was mostly in line with the recent trend (blue chart in Figure 2), but the trend is increasing slightly. Fruits and vegetables—which would likely be affected by rising fertilizer costs—tripled in contribution, month over month, from one basis point to three-and-a-half. Non-alcoholic drinks also added an incremental basis point, from four to five (perhaps in sympathy for those celebrating dry January and who have maintained their abstinence).

Core goods (purple chart in Figure 2), which account for 19.4% of the CPI, decelerated slightly month over month, but the underlying reasons are not as beneficial as the chart shows. The major laggard of the core goods group was used car sales, which brought the index down 4.7 bps in January and 7.6 bps in February. Because used car sales are pro-cyclical, consecutive declines in prices are more consistent with emerging recessionary pressures than with a benign normalization in auto supply; in weaker economic conditions, households often trade down to cheaper transportation options or sell vehicles to raise cash.

Core services (yellow chart in Figure 2), which hold the lion’s share of the index at a 60.6% weight, has declined steadily since peaking in early 2023. Core services contain the heavily weighted housing sector. Rent of shelter maintained its near linear decline, which should not be a surprise. (This indicator has a particularly large momentum factor, as noted in past Talking Points.)

Meanwhile, the PCE—the Federal Reserve’s preferred inflation gauge—matched expectations for January, rising by 0.3%, month over month. One could argue that markets yawned at January inflation data, given the raging war in the Middle East. Yet such data will undoubtedly be cited this week by the Federal Open Market Committee at its post-meeting press conference. In fact, given the upward drift in long-term inflation expectations, hawks at the Fed seem to have the upper hand.

One of the benefits of the PCE is that it places less weight on the housing index, as well as allowing for substitution among sub-indexes. For example, if beef prices were to rise precipitously, many consumers would likely change to alternatives, like chicken and pork. The PCE automatically shifts weight to these cheaper alternatives to reflect a more accurate proxy of spending, unlike the fixed-basket approach of the CPI.

While Fed officials have been under the customary blackout period ahead of a FOMC meeting, officials remained steadfast in their recent mantra of taking a wait-and-see approach to the future of interest rates. For instance, on March 6, Beth Hammack, president of the Cleveland Fed, said: “Under my base case, I think policy should be on hold for quite some time, as we see evidence that inflation is coming down and the labor market stabilizes further. But it’s easy to envision other scenarios, as well, so I see two-sided risks to rates.”

Susan Collins, president of the Boston Fed, echoed this point. “My baseline features a still uncertain inflation picture, with continued upside risks. This, combined with recent evidence suggesting a relatively stable labor market … argues for maintaining policy rates at their current, mildly restrictive levels for some time.” Figure 3 illustrates the evolution of market expectations for Fed policy, including the current policy range, the January 2027 federal funds rate futures contract, and the implied number of future rate cuts.

While two-and-a-half cuts of 25 bps were forecast less than 30 days ago, the market has changed its tune in recent weeks due to rising inflationary fears. For those remaining in the “threat of recession should bring about more cuts camp”—a reasonable case from an economic point of view—the market nevertheless disagrees. Indeed, the market is now less certain that even one cut will be delivered in 2026.

FROM THE DESK

Agency CMBS — It was a quiet week in agency and Ginnie Mae origination due to the run up in Treasury yields. For the week, spreads were flat to three bps wider. Swap spreads continued to tighten week over week, which helps some banks that look for large, full-term interest only (IO) origination. We expect that structure to garner stronger bids if this trend persists.

Municipals — AAA tax-exempt yields moved higher across the curve, week over week. The largest increases were in the belly of the curve, where 10 to 12-year maturities rose by as much as 17 bps. The selloff was driven by escalating tensions in the Middle East, rising energy prices, inflation fears, and higher Treasury yields. Market volatility led some deals—particularly refundings—to move to day-to-day pricing. Municipal bond funds had $612 million of inflows last week, marking the 11th consecutive week and bringing year-to-date inflows to $14.84 billion. Average weekly inflows in 2026 are now over $1.35 billion. Roughly 3% of last week’s inflows went to high-yield funds.

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