Bonds Retreat Ahead of Today's CPI Report

The yield on the 10-year treasury is 3.91%, just 1 basis point shy of the 2008 closing high set in mid-February. The bond market may be bracing for an ugly inflation surprise with the release of the April CPI this morning. The Street is looking for a +0.3% headline and +0.2% core inflation rate at the consumer level. However, there are plenty of reasons to believe the number could go higher.

Just yesterday, Knobias reported that import prices soared 1.8% in April, following an upwardly revised 2.9% increase in March. Compared to the same month last year, import prices have risen 15.4%, the biggest increase on record.

Gasoline prices soared 11% in April. While the Dept of Labor may use a lower energy input, it should be a significant number. In November, the CPI's energy component rose 6.9% and the November headline CPI spiked by 0.9%, surprising the market. Other inflation indicators follow (originally published on May 9, "Inflation and Retail Sales Data Loom Next Week"):

• Gasoline: From March 31 to April 28, the average price of regular gasoline soared by 31.3c, or 11%, to $3.613/gal according to Energy Information Agency data.
• Beef: Bloomberg News reported wholesale beef prices have climbed 13% since hitting a 2-year low on April 4.
• Pork: Wholesale pork prices rose 43% from the 5-year low set on April 1.
• Rice, wheat, corn and soybean prices were flat to lower in April.
• Apparel: In March a (1.3%) plunge in apparel prices helped hold the headline CPI to 0.3%.
• The Philly Fed reported its prices received index rose to 30.9 in April from 21.2 in March.
• The NY Fed reported its price received index rose to 20.8 in April from 15.7 in March.
• The ISM Manufacturing Prices Index for April rose to 84.5 (47-mo high) vs. 83.5
• The ISM Non-Manufacturing Prices Index for April rose to 72.1 (5-month high) from 70.8

Higher long-term interest rates are a negative for homebuilders (XHB) (0.9%) and financials (XLF) (0.7%). Companies with large portfolios of long term bonds (mortgage REITs and insurers) face some risk to book value.

Brokers are the lagging group in the financial sector following negative comments from Oppenheimer's Meredith Whitney.

An upside inflation surprise is less negative for the market during a slow economy than during a period of high capacity utilization. Yet it is still negative. A big number could actually reinforce the recent dollar rally, as it would bolster the notion that fed funds rate cuts are over.