The latest on rates, inflation, and recession risk

Whopper of a Producer Price Index this morning -- the overall PPI dropped 1.6% on the month, vs. forecasts for a 0.5% decline. The CORE PPI dropped 0.9%, against expectations for a 0.1% gain. That 1.6% decline matches the biggest monthly decline on record. The core rate decline was the biggest since 1993, driven in part by a record drop for light truck prices (and of course, the two-month, sharp fall in energy prices).

I think the real inflation right now is clearly in ASSETS, due to incredibly abundant liquidity (see my earlier posts for more).

The market reaction? 10-year Treasury Note yields tested ... but didn't break through ... recent lows in the 4.55% area. Likewise, Treasury futures prices failed to break out to new highs. Part of it is probably due to the fact we still have CPI to get out of the way two days from now. PPI and CPI results don't always correlate well. Part of it is also becauase October retail sales fell just o.2% against expectations for a 0.4% drop. Once you strip out gasoline sales (which fell along with prices), sales actually perked up 0.4%.

With the entire yield curve trading below the federal funds rate of 5.25%, we're in rarified territory. The bond market is going to have a hard time advancing further unless the Fed signals an imminent rate cut ... the economic news gets even worse ... or we get some kind of break in the credit or stock markets.

It's worth pointing out that the difference in yield between 3-month bills (5.09%) and 10-year notes (4.57%) is now 52 basis points. That's pushing the risk of recession in the next four quarters above 40%, according to Fed research. The table above shows the recession chance indicated by various levels of curve inversion (with the curve being defined as the difference between yields on 3-month bills and 10-year notes)