Stocks surged, bond yields dove, and the Canadian dollar jumped as the greenback weakened after the U.S. released inflation data for October that was tamer than Street expectations.
Headline October inflation was up 7.7% from a year earlier versus estimates of 7.9%. On a monthly basis, inflation rose 0.4% vs. estimates of 0.6%. Core inflation was also lower than expected.
The softer reading had an immediate impact on credit market expectations for interest rate hikes to come, in both the U.S. and Canada. The market is now assigning much higher probabilities of a more modest 50 basis point hike in the Federal Reserve’s key short-term rate in December and lesser odds of a 75-basis- point hike. And for the next Bank of Canada policy meeting on Dec. 7, the market is now pricing in a 76% probability of a 25 basis point hike in its overnight rate, versus 54% odds prior to the 830 am ET inflation data. The odds of a larger 50 basis point hike declined to 24% from 45%, according to Refinitiv Eikon data.
Here’s how the Street is reacting:
Stephen Innes, Managing Partner, SPI Asset Management:
This “is a massive bonus for risk assets as, ultimately, this will please the Fed, meaning 50 for December is a lock. After the terminal rate had been creeping up post-FOMC, traders went into CPI looking for an endgame and found it. The cool inflation print should mean the beginning of the end for inflation fears, and the Fed will feel much more comfortable ramping down. Indeed this is the kind of number that lifts all ships, as investors were not even close to being positioned for this type of inflation retreat. US Treasury yields drop profoundly and instantly. The 2-year yield collapsed a massive 20bp lower in the blink of an eye to 4.39%. And the 10-year down 10bp straight away from 4.07% to 3.97%. Implied pricing in the ED rates strips is down 25bp - taking a quarter point off Fed pricing.”
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David Rosenberg, founder of Rosenberg Research:
“The headline U.S. CPI came in at +0.4% MoM in October versus consensus views of +0.6% — if not for big increases in shelter (+0.8%), energy (+1.8%), and food (+0.6%), the CPI would have declined outright by 0.1%, the first dip back to deflation on this measure since May 2020. That attests to just how weak the U.S. economy has become. The two really key metrics deflated: services less rent came in at -0.1% MoM and core goods (excluding food and energy) fell 0.4% after a flat September. On the services side, we had prices decline in medical care, financial services, car/truck rentals, airlines, and the second slide in delivery services in the past three months — and that is the pulse right there on consumer demand. On the goods side, used autos deflated for the fourth month in a row, new car prices slowed sharply, and we saw sizeable price declines in apparel, furniture, and appliances.
The breadth of the price weakness was remarkable and the lags from sharply higher interest rates and the soaring U.S. dollar are only now percolating through the system. Treasuries are rallying hard and for good reason. As for equities, the instant reaction will fade as the reality of diminished corporate pricing power and earnings downgrades come to the fore — the major theme for 2023.
What does the Fed think about this number? Who knows. Powell already put everyone on notice that he needs to see a multi-month string of numbers just like this before shifting policy. So, they likely go 25 basis points — maybe 50 basis points — at the December meeting, but that is likely to be it for the cycle.”
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Katherine Judge, Director & Senior Economist at CIBC Capital Markets:
“The October inflation data for the US will provide some relief for policymakers, as core prices decelerated over the month. Excluding food and energy, core prices rose by 0.3% m/m, below the consensus expectation of 0.5%, representing a three-tick deceleration from the prior month’s pace. While the shelter component, which carries the highest weight in the core index, gained momentum, adding to increases in car insurance, recreation, new cars, and personal care, there were signs of the alleviation of supply chain issues feeding through to the drop in used car prices, while prices for medical care, apparel, and airfares also declined. That left annual core inflation three ticks lower at 6.3% (vs. 6.5% consensus). Both food and energy prices increased strongly over the month, although the former category decelerated, which left total prices up by 0.4% m/m (vs. 0.6% expected), and the annual rate of inflation at 7.7%, two ticks below the consensus expectation, and below the prior month’s 8.2% pace. While the deceleration in core prices is a welcome development, and we continue to expect supply chain improvements to feed through to the index more meaningfully ahead, the strength in core services still supports an outsized rate hike at the December FOMC.”
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Edward Moya, Senior Market Analyst, The Americas for OANDA, a retail foreign exchange dealer:
“This inflation report was a nice surprise. Inflation has been very slow to come down, but this report gives up hope that this deceleration with pricing pressures might bring back hopes of a soft landing. The headline reading came in lower-than-expected, but most traders were focused with the month-over-month decline with core prices. If this downward trajectory for inflation holds, then you can make a strong case that the bottom is in place for US equities. ...
This inflation was a good sign that the Fed is on the right path for winning this war with inflation, but there will still be a lot of variables thrown its way over the next couple of quarters. The Fed could easily bring rates to 5.00% and if inflation proves to be sticker, it could be as high as 5.50%.”
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Daniel Berkowitz, senior investment officer for investment manager Prudent Management Associates:
“While it always feels good to see markets rally, we think this morning’s rally is bordering on silly. The market is reacting as if this is the continuance of a multiple-month, downward trend in inflation, and it is not. This kind of sobering assessment of inflationary trends is likely the one to be on the minds of Federal Reserve governors, and when a hawkish FOMC meeting arrives in December, we may see some or all of the gains from days like today be erased.
In our estimate, inflation and interest risk continue to remain skewed to the downside. Despite the downward pressure on treasury yields, the yield curve remains highly inverted beyond short-term maturities, providing limited compensation for taking material duration risk. Further, the possibility looms that the market continues to underestimate the Fed’s terminal rate, even after the most recent recalibration. TIPS breakeven rates have also trended up over the last month, but we still believe these levels reflect overly optimistic expectations for inflation’s future path and will continue to tick up.
Of note, we continue to expect volatility in Treasury yields over the coming months, which may create a spillover effect into other asset classes given the importance of the Treasury market to global finance. A few factors including the Fed’s liquidity withdrawal via quantitative tightening, regulatory constraints on banks impeding market depth, and reduced demand from Japanese investors should continue putting upward pressure on yield volatility. The Treasury market is closely monitored by a number of key US departments, agencies, and personnel, though we believe this bears watching moving forward.
Today’s tap on inflation’s brakes, while welcome, also needs to be evaluated within the context of the jobs market, which remains strong, and the wage inflation this brings, poses a risk that prices will remain high as labor costs are passed along.”
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Derek Holt, Vice-President & Head of Capital Markets Economics, Scotiabank:
Regarding month-over-month annualized inflation readings, “every down month this year like this one has been followed by a surge the next time. Woo hoo inflation’s ebbing, whoops it’s not, rinse, repeat. I’ll cover the drivers below after an important caution. I think the massive market reaction is a combination of a hope-driven rally and positioning squeeze much more than is sensible with the modest new evidence at hand. There are two reasons for this.
One is that we don’t know if the relatively soft core inflation reading is simply a third head fake this year and at risk of being a repeat of the prior two occasions that were surrounded by otherwise hot readings. Recall that the softer than expected 0.3% m/m core reading in July prompted a sucker’s rally and stridently premature declarations of victory over inflation before a pair of 0.6% prints followed. String a few together and then we’ll see.
Second is that we’ll get another CPI report on the eve of the next FOMC meeting on December 14th. Recall that FOMC participants submit their forecasts and ‘dots’ on the Friday before the start of the meeting on Tuesday but can change their forecasts and dots right up to the eve of the decision (ie: Tuesday night). There is probably going to be a high bar to risking abrupt changes to what they submit after the next batch of inflation readings, but it’s possible if CPI surprises in either direction again. I suspect the way we’re leaning now is toward 50bps in December pending further information and possibly higher terminal rate guidance in the dots based on Powell’s recent press conference.”
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Sal Guatieri, Senior Economist with BMO Capital Markets:
“The stiff backbone of U.S. inflation finally cracked in October, though one month doesn’t make a trend. ... The October report marks only the second time in the past year that the core measure has risen a relatively mild 0.3% in a month, so it’s unclear whether this is the start of a slower trend. What is becoming clear is that goods prices are weakening as consumers push back against price hikes, while service costs (notably shelter) remain brisk though they no longer appear to be accelerating. That’s a small win for the Fed. The FOMC will have one more CPI report before its December 14 policy announcement. For now, today’s release weighs toward a slower cadence (50 bps), but only time will tell where the terminal rate ends up. We currently see two additional 25 bp moves early next year.”
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Paul Ashworth, Chief North America Economist, Capital economics:
“The better than expected 0.3% m/m increase in core consumer prices in October won’t on its own persuade the Fed to drop its hawkish stance. But we expect this to mark the start of a much longer disinflationary trend that we think will convince the Fed to halt its tightening cycle early next year, with the policy rate peaking at 4.50% to 4.75%, and to begin cutting rates again before the end of 2023.
Overall, with headline CPI inflation still at 7.7% and core inflation at 6.3%, the Fed won’t overreact to one month’s data. But if, as we believe, this is the start of a new disinflationary, trend, then expect a marked change in tone early in the New Year.”
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Thomas Feltmate, Director & Senior Economist, TD Economics:
“It’s been a while since CPI has surprised to the downside! This morning’s print bucked the trend, with the year-over-year reading of headline inflation easing to a pace not seen since the beginning of the year. The pullback in core goods prices was perhaps the most encouraging development, as it would appear that softening consumer demand is finally manifesting in (some) disinflationary pressure. ...
While we suspect the Fed has reached a point where they’ll need to start dialing back on the pace of rate hikes, Chair Powell was explicit in his last press conference that the end-point has likely been revised higher. With inflation still a long way from target and the labor market historically tight, it is entirely possible that the fed funds rate reaches 5% by mid-2023.”
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Greg Valliere, Chief U.S. Policy Strategist at AGF Investments:
“One report doesn’t make a trend, but this new data was very encouraging. It improves the chances that the Federal Reserve may be able to slow its aggressive interest rate hikes by mid-winter. They’re not finished yet, but if we get a couple more reports like the one we got today, the Fed — and the markets — may conclude that inflation is much less of a crisis.”
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Jocelyn Paquet, economist with National Bank Financial:
“While inflation continued to hover at unacceptably high levels in October, signs of a turnaround were becoming clearer. Price increases have already slowed significantly in the goods segment and this trend is likely to continue going forward judging by current setbacks in the manufacturing sector. Indeed, the ISM PMI reported the weakest manufacturing expansion in October since the early months of the pandemic while new orders contracted for a fourth time in the past 5 months.
Signs of improvement on the supply chain side were also clearly visible in the report, which is especially important from a price change perspective. The input price index fell below 50 for the first time in two and a half years while the supplier delivery time indicator reported the largest decline since March 2009. Combined with shrinking new orders, these declines resulted in the first decrease in backlog in 28 months. Other factors are also fueling our hopes for a deceleration in goods prices, including lower international transportation costs, and the strength of the U.S. dollar, which, when combined with lower production costs in China, is helping to drive down import prices. On the services side, the return to more acceptable inflation levels may take longer. However, the process seems to be underway. ...
The strength of the labor market should continue to support prices in other service categories via significant wage increases. But even here, there is a glimmer of hope on the horizon as hiring appears to be slowing. ... Looking ahead, we continue to believe that job growth will slow significantly, putting downward pressure on wage growth and, in turn, services inflation. If this scenario pans out, the central bank should seize the opportunity and end its monetary tightening cycle no later than the first monetary policy meeting of 2023, otherwise a recession would become nearly inevitable. It’s worth noting though that a Fed pivot would not prevent a significant slowdown in growth next year.”
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Charlie Bilello, director of research at Pension Partners, LLC:
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Mohamed A. El-Erian, President, Queens’ College, Cambridge University. Advisor to Allianz and Gramercy. Wharton Professor.
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Paul Krugman, Nobel laureate. Op-Ed columnist for The New York Times: