As I look with ever more confusion at the equity market, I am thankful that my expertise after all is in the bond market. Sure, the bond market is the one that is explicitly manipulated by the central bank right now, but in a way it is comforting that it is out in the open. Also, it creates great anticipation in my mind about what the Fed will do when they want to put the market somewhere and the market doesn't want to go. That will be a fun day.

The Non-Manufacturing ISM was marginally weaker-than-expected at 57.3 versus expectations for 59.5, but it remains at a relatively high level. Of more interest were the minutes of the FOMC meeting, some snippets of which are below.

"Sizable increases in prices of crude oil and other commodities pushed up headline inflation, but measures of underlying inflation were subdued and longer-run inflation expectations remained stable."

Well, not really. The Michigan survey's measure of consumer expectations for inflation 5-10 years ahead jumped considerably this month, and surprisingly. Later, the minutes explicitly mentioned the survey before dismissing it:

"According to the Thomson Reuters/University of Michigan Surveys of Consumers, households' near-term inflation expectations increased substantially in early March, likely because of the run-up in gasoline prices; longer-term inflation expectations moved up somewhat in the early March survey but were still within the range that prevailed over the preceding few years."

As the chart below shows, this is only true because the "range" was extended on the high side in 2008 by the oil price spike and headline inflation over 5%.

Still within the range...I guess.

It seems disingenuous to say we are "still in the range" when we're at the absolute limit of the last decade's range with the singular exception of the inflation spike in 2008 that had policymakers pooping in their pants.

My suspicion is that the Fed is referring mostly to 5y, 5y forward inflation taken from the inflation swaps market or TIPS breakevens (see Chart below, source Enduring Investments). SOMA manager Brian Sack has written previously about 5y breakevens compared to 5y, 5y forward BEI and seems to be a fan of that measure. Certainly, the Fed focuses a great deal on it. In this case, that seems curious since the Fed is actively holding down the Treasury curve, which constrains breakevens by artificially keeping interest rates lower than they would be without a $600bln buyer.

Well, 5y5y (the green line) is still contained. Thanks to the Fed holding down longer-term Treasury yields.

But moving on, more from the minutes:

"In response to special questions, dealers reported some increase in the use of leverage over the prior six months by traditionally unlevered investors-in particular, asset managers, insurance companies, and pension funds. In addition, dealers reported an increase in leverage over the past six months by hedge funds that pursue a variety of investment strategies. More broadly, while the availability and use of dealer-intermediated leverage had increased since its post-crisis nadir in mid-2009, a review of information from a variety of sources suggested that lev-erage [sic] generally remained well below the levels reached prior to the recent financial crisis."

It seems odd to speak nonchalantly about the increase in the use of leverage "by traditionally unlevered investors." This would seem doubly chilling to me, even if overall leverage "generally remained well below the levels reached prior to the recent financial crisis." First of all, I would hope that we all agree that the level of leverage reached in 2008 wasn't just a little high, but was really way too high for a healthy financial sector. Second of all, the Fed's worst nightmare would be if leverage surged back and brought money velocity (a related concept) back up with it. It was the crash in velocity that caused the flirtation with deflation, not the 5-10% M2 growth rate of 2008 through late 2009. We can be reasonably calm about inflation right now only because M2 has been growing relatively feebly (although back to 4.44% over the last 52 weeks). But all bets are off if velocity increases 20%. Then the Fed would need to drain aggressively to restrain inflation.

To me it seems like the Fed is missing some of the big lessons of the crisis, from an inflation-observer's point of view. However, I was delighted to read this fairly enlightened exchange in the minutes:

"In contrast to headline inflation, core inflation and other measures of underlying inflation remained subdued, though they appeared to have bottomed out. A number of participants noted that, with significant slack in resource utilization and with longer-term inflation expectations stable, underlying inflation likely would remain subdued for some time. However, the importance of resource slack as a factor influencing inflation was debated. Some participants pointed to research indicating that measures of slack were useful in predicting inflation. Others argued that, historically, such measures were only modestly helpful in explaining large movements in inflation; one noted the 2003-04 episode in which core inflation rose rapidly over a few quarters even though there appeared to be substantial resource slack."

Exactly the point I've been making for some time - if you're relying on traditional aggregate demand/aggregate supply analysis to forecast inflation, you're likely to be very disappointed. There is just not a lot of reason to think that these are anything more than "modestly helpful." I am delighted that the discussion turned this way, but the point appeared to have been dropped for now.

Amazingly, there was zero discussion of the Bernanke press conferences! That was striking to me, since the decision to hold four press conferences a year is easily the biggest communications-related decision - and even more difficult to reverse than QE2 - in the last 5-10 years. I know they've been thinking about it for a while, but it is rather cavalier of the Committee to blithely brush past it in the meeting that immediately preceded the announcement!

None of this had any market impact of note. As I write this (at 3:30ET since I have an engagement in the city later), stocks are unchanged and while bonds are down on the day they didn't react appreciably to anything in the minutes.

There is nothing on the economic calendar for Wednesday, so presumably we can expect another slow trading session. However, I want to share one more picture with you, and that's the seasonal chart of bond yields over the last thirty years:

Average deviation of 10-year yields from the annual average, last 30 years.

The basic shape of this picture hasn't changed for as long as I have been in the business. From April into early summer, yields tend to rise (about 70% of the time from early April over the next 60 days); they irregularly rally in the summer but with no tradeable consistency, and then starting in September with great regularity rates fall fairly sharply. In the context of this chart, we should be wary about the recent back-up in yields - although yields are in the middle of recent ranges, and although the seasonal pattern here is not automatic, it does suggest that there is a better chance of a break higher in yields than of a break lower in yields over the next month or two.