‘More Work To Do’

Market participants weren’t amused with the hottest read on US core inflation in 40 years, even as markets themselves oscillated wildly during a volatile session on Wall Street.

The initial reaction to another disconcerting CPI report out of the world’s largest economy was predictable. Risk assets cringed, the dollar firmed and Treasurys bear flattened sharply, before what looked like systematic flows and programmatic buying of some kind triggered a manic reversal, alongside reports that Liz Truss is pondering a fiscal U-turn.

When taken in conjunction with last week’s jobs report, which featured a sturdy headline and downticks in participation and unemployment, September’s CPI figures mean a fourth straight 75bps rate hike from the Fed next month is assured. Hope of a downshift to a 50bps cadence is dust in the wind.

It was “an unquestionably strong inflation read concentrated in housing no matter how one slices it, and from here we’ll look for terminal assumptions to climb and the curve to flatten,” BMO’s Ian Lyngen said.

Barclays changed their Fed call to 75bps in November and December. A little over an hour after the data was released, market pricing reflected 40% odds of a three-quarter point move at the December gathering.

Assuming 75bps next month, a comparable move in December would mean the Fed hiking in three-quarter point strides for five consecutive meetings. Such an outcome would’ve been summarily laughed out of the room had you suggested it nine months ago.

Some observers and, one imagines, a few enterprising traders, might speculate on a 100bps hike next month, but that feels less likely than it did during the other two episodes when bets on a full-point move made their way onto the radar. With signs of “breakage” proliferating, such a broadside seems risky.

Terminal rate pricing inched closer to 5%, and there’s now a lot more in the way of buy in around the notion that the Fed can hold somewhere close to 4.5% through year-end 2023 (figure above). I doubt it. I really do.

Certainly, you could argue stocks need to fall further even to reflect the higher odds of a 75bps December hike atop next month’s assumed move. “Either the OIS curve is exaggerating or other assets will extend declines,” Bloomberg’s Sebastian Boyd wrote. Although there’s “a lot of data between now and the December FOMC meeting” and thereby “plenty of room for hope,” the read-through in the near-term is that “assets must price in the new reality,” he added. “Neither inflation nor jobs leave any room for a Fed pivot in November.”

That said, the share of items running above their five-year average dropped. I doubt that’s any comfort, though. The “sticky” and “trimmed” gauges moved up (figure below).

The Cleveland Fed’s trimmed mean gauge rose 7.3% YoY last month. The Atlanta Fed’s “sticky” index was up 6.5% on a 12-month basis, and 8.5% on a one-month annualized basis.

“The increase in the annual rate of core inflation is not a good story [and] 75bps is indeed the solid call for the November meeting, but we’re still looking for the Fed to slow the pace to 50bps in December,” ING’s James Knightley remarked. He cited the slowing economy and “more evidence pointing to weakening corporate pricing power.”

“The second-round effects of inflation are clearly being felt across the economy,” SPI Asset Management’s Stephen Innes wrote, suggesting investors “need to think more seriously about 75bps in December.” “The FOMC minutes indicated a data-dependent Fed that requires a high hurdle to pause its rate-hiking cycle [and] that hurdle just got immeasurably higher,” he went on to say.

We all know how this ends. “QT continues and the combination of a higher Fed terminal rate, QT and deleveraging moves from UK pensions have pushed 10-year real rates to 1.63%,” TD remarked, in the wake of Thursday’s data in the US. “We think the move in real rates and tightening in financial conditions will hurt the economy over time and bring forward the next recession.”

Joe Biden weighed in too. Consumer prices are too high, he said, adding that there’s more work to do. “If Republicans take control of Congress, everyday costs will go up — not down,” the president remarked.