Financial markets are rallying sharply following a greater than expected decline in both headline and core CPI for October. Fifteen minutes following the data release, S&P 500 futures are up more than 3%, and front-end Treasury yields are down 20-25 basis points. Core prices rose 0.3% m/m versus expectations of a 0.5% gain, and the downside surprise was mostly attributable to declines in used vehicle prices (-2.4% m/m) and medical care (-0.5% m/m), as well as moderation in the more heavily weighted category of owners’ equivalent rent (OER) to 0.6% (still high). Today’s report fuels the narrative that peak inflation has been reached, but unfortunately, that narrative has emerged multiple times in 2022 and proved to be premature. Regardless, markets have eagerly sought any signs of a pivot, and today’s report helps on that front. If nothing else, it solidifies market pricing for a smaller 50 basis point rate hike at the December meeting (for now at least), and market pricing for the terminal fed funds rate is now 4.85%, down 30 bps from last week’s levels.

We would be more cautious in assuming today’s report represents a paradigm shift with regard to inflation risks. As noted yesterday, used vehicle prices, which are typically more volatile month-to-month, were expected to fall in October (just a matter of how much), and the largest component in the core CPI calculation – shelter costs – is expected to remain elevated for several months. Fed Chair Powell has made clear that the mistakes of prematurely ending tightening cycles in the 1970s are fresh on the minds of current Fed leaders, hence the ‘higher for longer’ guidance. The irony in today’s market reaction is that loosening of financial conditions via the rally in equities and bonds actually works against the Fed’s effort to suppress these inflation risks.  All that said, a bond market rally of both rates and spreads is certainly a welcomed sight for this portfolio manager.

Jason Haley
Chief Investment Officer