Treasuries and mortgage markets opened softer this morning but nothing major. Over night China raised interest rates for the third time since the middle of Oct as its inflation rate hangs at 4.0% for the third month. In Europe German Dec industrial production fell unexpectedly for a second consecutive month on colder weather that hampered construction, down 1.5% frm Nov and against +0.2% that was expected. The US stock market isn't being hit early but with the weaker data from Germany Europe's stock markets trading lower. In Germany, where the economy is booming and import-price inflation is running at the fastest pace in 29 years, workers are demanding bigger pay increases. Inflation concerns are spreading abroad (China, India, Germany to name a few); not here yet but investors in long term fixed income investments (10 yr notes and 30 yr bonds and long term corporates) are not waiting for the whites of the eyes. With interest rate so low any thoughts of inflation are going to pressure rate markets.

Are we headed for an increase in inflation? If so, will it be much of an increase? Inflation concerns are currently based on rising energy and commodity prices, it depends on whether commodity prices remain at these or higher levels; producers and businesses so far have been able to absorb price increases but that is likely over. Unless prices decline inflation will increase a little; the Fed wants it up to 2.0% frm the present 0.8% to 1.0% rate. The bond market is moving up in yield anticipating deflation is now dead, with the very low existing rates just the talk of a small increase in inflation has driven rates up 30 basis points on the 10 yr and 20 basis points on mortgages in less than a week.

Earlier this morning Richmond Fed's Lacker was speaking, he said he wants the Fed to re-consider the remaining QE 2 now that the economy is growing faster than the Fed expected. Lacker has been dissenting on about every QE move the Fed has undertaken. He is concerned that inflation will increase as it is in China and many emerging markets. It is highly unlikely the Fed will abandon QE 2 but equally unlikely there will be a QE 3 as some have mused recently. Lacker estimates the US economy to grow 4.0% this year; he sees a better jobs market, "robust" consumer spending, and the inflation rate between 1.5% and 2.0%. 

The Johnson Redbook retail report this morning reported chain store sales for the first week of Feb up 1.7% frm Jan; yr/yr +2.7% frm the the first week of Feb. 2010.  

Looking to tomorrow, Ben Bernanke is scheduled to testify at the House Budget Committee. He will be grilled to explain what the Fed is planning to withdraw its easing. His testimony is the first that we don't have Barney Frank running to testimony, although barney will have his moment. With Republicans now in control of the committee the hearing will get a lot of attention.

The only thing scheduled today is the $32B 3 yr note auction at 1:00 this afternoon. Auctions this week will be interesting to monitor as yields have broken out of their month and a half long ranges and may entice buyers at these higher levels. If demand isn't strong look for the bond and mortgage markets to work higher in rate and lower prices. The 3 yr usually sees decent demand, tomorrow's 10 yr auction is what we are concerned with, weak demand will push mortgage rates higher.  



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