Why The Bond Market Thinks The Fed Will Look Through The Oil Shock

April CPI Tuesday May 12 is the inflection — Headline expected at 0.6% m/m (down from 0.9%) and 3.7% y/y (up from 3.3%). Core expected at 0.4% m/m (up from 0.2%) and 2.7% y/y (up from 2.6%). Kalshi prediction markets and analyst consensus are aligned at the same numbers, so a clean in-line print isn’t pricing a major surprise. Levels: core 0.4% m/m / 2.7% y/y; headline 0.6% m/m / 3.7% y/y.
CPI swaps curve has May at ~4.2%, easing through the summer — the curve prices May at ~4.2%, June at ~4.0%, July at ~3.9%, and August at ~3.7%. The shape is heavily oil-dependent: if oil moves higher, the curve goes higher; if Iran simmers and Hormuz reopens, the curve flattens. Levels: May ~4.2% / Jun ~4.0% / Jul ~3.9% / Aug ~3.7%.

The decomposition tells you what the market believes about the Fed — Since the end of March, 10-year real yields have fallen, 10-year inflation expectations have risen, and nominal 10-year yields have gone roughly sideways. The decomposition is the tell: if the market believed the Fed would be aggressive on rates, real yields should be rising. They’re not. The market is willing to bet the Fed will look through this oil shock the way it looked through 2021.

G-3 reaction-function divergence priced in — Markets have moved to price the ECB raising rates two to three times this year and the BOE the same. For the Fed, the market has just removed two or three previously priced cuts — no hikes priced in, just an end to easing. That’s a meaningfully different reaction function from the rest of the BOE and ECB.

Kevin Warsh transition is the wildcard on Fed policy — The market doesn’t know what Warsh’s first policy action looks like once he steps in. Pre-oil shock, his messaging was dovish-leaning, which may be feeding the market’s current read of Fed inaction.

DXY below the 100/101 inflection — The dollar has tested 100/101 multiple times and hasn’t been able to break through. Same level as last weekend, still unresolved. A hot CPI surprise or oil moving back up could be the catalyst. Levels: 100 / 101.

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