Stock prices experienced a decline while Treasury yields surged, as new data heightened speculation that the Federal Reserve is far from declaring victory over inflation. This has led to increased bets on another interest rate hike, effectively bringing them back into coinflip territory.

The S&P 500 halted a four-day winning streak, and bank shares notably underperformed as investors eagerly awaited earnings reports from major financial institutions, including JPMorgan Chase & Co., Citigroup Inc., and Wells Fargo & Co., which are set to kick off the earnings season on Friday.

Treasuries saw a broad drop in value, with the 30-year rate surging by as much as 18 basis points following a $20 billion auction of the securities that drew weak demand. Meanwhile, the U.S. dollar gained ground, marking its longest losing streak since March.

Swap contracts have pushed the odds of another quarter-point interest rate hike by the Federal Reserve back to approximately 50%, a substantial increase from the approximately 30% odds seen just a day earlier. Expectations for the first rate cut shifted from June to July.

The core consumer price index (CPI), which excludes food and energy costs, saw a 0.3% increase last month. On a year-over-year basis, it rose by 4.1%, the lowest level since 2021. Economists generally consider the core CPI as a more reliable indicator of underlying inflation compared to the overall CPI, which increased by 0.4% due to rising energy costs. Forecasters had predicted a 0.3% monthly advance in both the overall and core measures.

Richard Flynn, managing director at Charles Schwab UK, commented on the implications of this data on interest rates, stating, “Whether or not the Fed opts for hikes, it’s unlikely we’ll see rates drop below where they are for as long as the inflation dragon proves difficult to slay.”

While some market indicators suggest the possibility of a Fed pivot to rate cuts next year, the likelihood of such a move is somewhat lower. Don Rissmiller at Strategas emphasized that it’s still too soon to consider rate cuts and suggested that the Fed may pause in November.

Notably, several Fed officials have indicated that the turmoil in bond markets may temporarily suspend the need for further tightening. Fed Governor Christopher Waller stated that the central bank can take a wait-and-see approach with interest rates as financial conditions tighten. Vice Chair Philip Jefferson and Dallas Fed President Lorie Logan also expressed similar sentiments, acknowledging the impact of rising risk premiums in the bond market on economic cooling.

Matt Bush, U.S. economist at Guggenheim Investments, expressed skepticism about the likelihood of additional rate hikes and suggested that a slower economy in the fourth quarter, along with a weaker labor market, could alleviate the need for further hikes.

The Consumer Price Index data has added a layer of uncertainty for Fed policymakers. Tiffany Wilding at Pacific Investment Management Co. noted that despite the tightening in financial conditions, the Fed may still proceed with the projected hike in the second half of 2023. The outcome remains a close call.

Market experts offered varying perspectives on the implications of this data for the Fed and future interest rate decisions. Jason Pride of Glenmede pointed out that the CPI report did not suggest that the Fed has completely tamed inflation, and another rate hike might remain on the table. James Rossiter of TD Securities considered this data as a potential challenge to the view that no further hikes would occur.

In contrast, Giuseppe Sette at Toggle AI emphasized that the Fed’s rate hikes may already be appropriate, and the hiking cycle could be at an end. Mike Loewengart at Morgan Stanley Global Investment Office noted that the data did not significantly alter the outlook for inflation and interest rates, with odds favoring the Fed leaving rates unchanged in November.

The bond market’s message about continued inflation concerns and the Fed’s commitment to keeping rates higher for a prolonged period is a coinflip, according to Chris Zaccarelli, Chief Investment Officer at Independent Advisor Alliance. Will Compernolle, a macro strategist at FHN Financial, noted that while the data may not be enough to prompt an immediate rate hike, it could shape market expectations for a future hike.

Krishna Guha, Vice Chairman of Evercore, stated that the CPI report, while not favorable for the Fed, would likely keep the central bank in wait-and-see mode. He also highlighted the potential for tighter financial conditions and higher yields in the coming months, suggesting the Fed may be done with rate hikes.

In summary, the markets are grappling with uncertainty and potential shifts in the Fed’s approach as inflation concerns persist and the central bank assesses its next moves.

Photo Source: Google

13th October, 2023
By Delino Gayweh
Serrari Financial Analyst