A Swing and a Miss for Inflation Estimates

Well we started to sound like a broken record harping on the impact year over year inflation would have on the MBS market this month. And we are glad we did!

Quick Review – this time last year, nobody was spending money. This created negative inflation. This year, a lot of people are spending money. This created a large amount of inflation. So, when you look a negative number going to a positive number year over year, there is a huge % increase.

Many news outlets acknowledged that inflation would creep up but many estimated that it would not reach the Fed’s goal of 2%. If you remember, last months 1.6% inflation reading sent the MBS market into a downward spiral. Today’s inflation number is 3.0% – an 87% increase!

Why is inflation bad for the MBS market – put simply? Because increasing inflation means that the dollar is worth less. Large companies invest in MBS’. These companies want a return on their money. When rates are 4% and inflation is 1%, their effective return is 3%. But if inflation rises to 3% (like it did today), their effective return drops to 1%. So, these companies now have to raise their rates to 6% to get the same return they were getting before.

The MBS market has plummeted 36 bps so far this morning with no strong floor of support. We are holding a strong locking bias.