Inflation Meets US Midterms In High Stakes Week

The data calendar in the US is sparse this week with a notable exception: CPI.

The updated read on consumer prices will show core inflation remained stuck near four-decade highs in October. Consensus expects 6.5% from the YoY core print, not materially different from the prior month. On a monthly basis, core prices probably rose 0.5% (figure below), inconsistent with a rapid decline in the 12-month readings to target.

Headline prices probably rose 7.9% YoY last month, down from the prior month but not enough to matter for Fed officials who, while inclined to reduce the pace of rate hikes going forward, readily concede there’s virtually no evidence to suggest price pressures are abating.

Some would quibble with the idea that evidence of pipeline disinflation is wanting. They’d point to a bevy of ostensible leading indicators. I won’t argue with any such protestations, other than to state the obvious: Whether or not inflation is set to fall and whether or not rate hikes are even capable of corralling inflation, the Fed is grappling with very bad optics and associated questions about institutional credibility. The US doesn’t have price stability. The US does have something close to full employment. The Fed has two jobs. One’s met, the other not.

“Within the core measure, we’ll be watching the contribution of OER/Rent with the bias that while higher mortgage rates have slowed the real estate market and marginally weighed on prices, there has yet to be any evidence of this flowing through to the inflation data,” BMO’s Ian Lyngen and Ben Jeffery said. “There is no case to be made for an outright decline in shelter costs during the fourth quarter, although a moderation in the pace of increases remains our baseline assumption,” they added. “In addition, the decline in used car prices that is evident in the wholesale data has heretofore been conspicuously absent as an influence on the prevailing inflation complex.”

Markets will continue to refine expectations for the terminal rate. The peak is now seen in May or June well above 5%. Markets are still looking for cuts in the back half of 2023. The Fed would like to dispense with that notion, but there’s far too much ambiguity around what 5% funds will mean for markets and the economy for officials to convince traders that holding terminal will be feasible for any extended period of time. The 2s10s is the most inverted since the 80s.

For what it’s worth, a NY Fed gauge of supply chain friction suggests price pressures “should” abate, as does ISM prices (figure below).

Those are a few, among many, of the leading indicators mentioned above.

“Global central banks might have a ‘ways to go’ before pausing. Following the hawkish FOMC meeting the market was quick to reprice a higher terminal fed funds rate,” SocGen’s Subadra Rajappa wrote. “We expect bonds to retain a bearish bias this year as inflation remains the dominant theme,” she added. “Higher for longer argues in favor of flatter curves, especially as recession risks continue to rise.”

Speaking of recession risks, TD’s Priya Misra noted that although “households still have accumulated savings, the stock of savings has been declining.” The figure (below), illustrates the point.

“We think as the buffer declines, spending will fall,” she went on to write, in a note floating a tactical long in 10-year US Treasurys.

“The market is already pricing for a 5.2% terminal rate, and we think too few cuts are priced into 2024,” Misra said, noting that the “Fed can’t be preemptive on easing” and “has to stay the course” in the near- to medium-term due to elevated inflation. The implication was that the economy will eventually slow, although Misra conceded it’s “impossible to pick the top in rates,” while noting a persistent lack of buyers in duration and still-strong data. Consumer credit figures for September are due Monday.

Also on deck in the US this week: NFIB, the preliminary read on University of Michigan Sentiment for November and a long list of Fed speakers, including Collins, Mester, Barkin, Williams, Waller, Logan and George.

Of course, the elephant in the room is a potential GOP takeover of Congress (there’s a joke there if you look hard enough). In 2022, “takeover” just means Republicans winning elections. It might mean something different in 2024. Donald Trump is likely to announce a new White House run within days.

It’s possible markets won’t know the composition of Congress immediately depending on how tight the Georgia Senate race turns out to be and, more generally, how contentious every close race ends up being. As a reminder: In American politics “contested” no longer just means neck-and-neck campaigns on election day. Increasingly, it means whoever loses is assumed to literally contest the result.

Over the weekend, Trump took aim at would-be GOP presidential challenger Ron DeSantis, branding Florida’s bellicose governor “Ron De-sanctimonious.”