Inflation is one of the Deadly enemies interest rates. If dollars in the future will buy less than they do today, investors must set higher and higher rates on the money they lend in order to achieve the same returns. With that in mind, we would be well within our rights to assume that a surprisingly high reading from a key inflation report would push rates up. In many past cases, this is exactly how it is, but that is not what has happened today.
To be fair, the markets traded on conventional wisdom within the first 20 minutes after the inflation report was released. But from then on the bond market rallied (i.e. bond prices rose and yields fell, implying lower rates for the mortgage market).
What’s new with the paradoxical reaction? There are a few moving parts. The simplistic answer circulating is that this inflation “was not enough” to derail the Fed’s commitment to maintain policies that support lower rates. That could be a factor, of course, but the unequivocal motivation is much more esoteric. It is an imbalance of trading positions in the bond market and the subsequent exploitation or punishment of this imbalance.
In market jargon, it is a short press and that basically means that so many traders were betting on higher rates that they were vulnerable to anything that pushed rates back the other way. Such a push would force these traders to buy bonds in order to avoid further losses. This buy pushes the rates even lower, potentially reaching the stop-loss level for the next group of online traders.
This is mostly a phenomenon that occurs in US Treasuries, but mortgage-backed bonds also improved steadily throughout the day. As a result, lenders increasingly remembered the first mortgage rate sheets and free improved conditions (aka a “positive reproach”). Some of these lenders have done this more than once, in fact! But even then, it is not in their nature to pass all market gains on to their price schedules in a single day. As such, bonds would only need to stay relatively stable for further improvements tomorrow. To be clear, this is just an if / then statement and not something you would like to take for granted as a prediction.