The December CPI report released on Thursday was a pleasant surprise for investors. The headline CPI fell -0.1% month-over-month, and the year-over-year measure fell to 6.5% from 7.1% the previous month. Core CPI, the measure that excludes food and energy, rose 0.3% over the previous month, a slight uptick from the 0.2% previously reported. Core CPI has fallen to 5.7% year-over-year from the peak of 6.6% reported last September. The market breathed a sigh of relief as witnessed by the massive rally in the long bond on the day of the release, closing nearly two points above the previous day’s close. We suspect that much of the rally was driven by short covering, driving the yield-to-maturity down below 3.6%. At that yield level it’s hard to justify buying from a fundamental perspective.

We had a feeling the government economists wouldn’t let 2022 get away without a little post-FOMC volatility. A summation of the economic releases this week is that the housing market stinks, inflation continues to be a problem, and consumer confidence ticked up last month. We’re skeptical of that last point. Both the Conference Board and the University of Michigan showed an uptick in confidence despite the continued array of layoff announcements. Our conclusion is that the uptick is directly correlated to the drop in gas prices and nothing more.

December is a tricky time for the capital markets as banks, brokers, and investors all endeavor to close the year with their respective portfolios 100% invested. Carrying cash over “the turn”, as year-end is colloquially referred to, is not acceptable in the capital markets. As a result, markets can become volatile to the point of seeming irrational. This year that irrationality is most evident in the Treasury Bill market. We refer to the soon to mature December 15th Treasury Bill, although the entire nearby Bill market has also been volatile. The Dec 15 Bill yielded 3.15% at the close of November but ended the day yesterday yielding 2.39%. Logically, that makes no sense. The overnight Fed Funds rate corridor is 3.75% to 4.00%, and the Fed Reserve Repo program offers a set 3.80% rate for the institutions that qualify for the program, and yet the near-term Bill curve continues to be in disarray as we approach the end of the year. One needs to look no farther than the “Calculated New Cash/Pay Down” section of the Treasury Direct website to understand why. Between December 6th and December 13th the Treasury paid down $76 billion in Bills; that’s to say that they sold $76 billion Fewer Bills than the amount maturing. In effect, the Treasury tipped the supply/demand of Treasury Bills out of balance which has resulted in wild gyrations in the Bill market. The Treasury will refill their coffers somewhat next week with net new cash of $64 billion when they sell the new 3-year, 20-year and 30-year securities, but that should not solve the Treasury Bill imbalance. As a result, we expect Treasury Bills to continue to trade rich to the Fed Funds target and the Reverse Repo program into year end.

The Federal Reserve released the minutes of their last Open Market Committee meeting at 2:00 p.m. on Wednesday, the afternoon before Thanksgiving. There are a few days on the calendar when liquidity is razor thin and Thanksgiving eve is one of them. The minutes were particularly anticipated as several Fed speakers had recently hinted at reducing the magnitude of the rate hikes going forward. That suspicion was affirmed in the “Participants View” section. The exact quote was “…a substantial majority of participants judged that a slowing in the pace of increase would likely soon be appropriate.” The key words in the quote were “substantial majority.” Remember, committee votes do not need to be unanimous; a simple majority is required, and a substantial majority tells me that they have that. We interpret that statement as the Fed communicating that the December hike will not be 75-basis points, with a 50-basis point hike more likely. The minutes also acknowledged that rate hikes impact the economy with a lag, and they are starting to see evidence of slowing. But any hint of policy action in the New Year was avoided entirely.

Finally, a downward bias to the Consumer Price Index! That’s not to say that prices are contracting. In fact, taking it at face value, the inflation numbers are still too high. But the rate of increase is falling, which is welcome news for consumers. Core CPI, the measure that excludes food and energy, rose 6.3% year-over-year, falling from a year-over-year increase of 6.6% last month. On a month-over-month basis the measure rose 0.3%, down from 0.6% last month. That’s a welcome improvement and comes just in time for the Fed.