U.S. equities were seen rallying sharply on Tuesday following the release of the Consumer Prices Index (CPI) for October, which was lower than expected across the board.
The market's lack of anticipation for a softer number suggests a positive response to the data. Tuesday’s report is perceived as good news for the Federal Reserve, and it is likely to take a December rate hike off the table.
Soft CPI Fuels Stocks Rally
The underlying U.S. inflation, as measured by the core consumer price index that excludes food and energy costs, rose by less than forecast in October. According to data from the Bureau of Labor Statistics (BLS), the core CPI increased by 0.2% from September, while analysts were looking for a jump by 30 basis points.
Economists often consider the core gauge as a more reliable indicator of underlying inflation than the overall CPI, which includes more volatile components like food and energy prices. The overall CPI was restrained in October, impacted by lower gasoline prices.
Inflation increased by 3.2% on an annualized basis in October, marking a deceleration from the rate of 3.7% seen in September. This decline represents the first drop in the reading in three months. On a month-on-month basis, the CPI registered 0.0%, down from 0.4%. Economists' expectations were for the figures to show a 3.3% annual increase and a 0.1% rise from the previous month.
Looking below the surface, the CPI report displayed several noteworthy trends. The index for shelter continued to rise, offsetting a decline in the gasoline index, resulting in a stable seasonally adjusted index.
The energy index fell by 2.5%, primarily due to a 5% decline in the gasoline index, while the food index increased by 0.3%. Food at home and food away from home contributed to the overall increase, BLS said.
Looking at the annual changes, the all-items index rose by 3.2% for the 12 months ending in October, a decrease from the 3.7% increase in September. Less food and energy, the index rose by 4.0% over the last 12 months, marking its smallest 12-month change since September 2021. The energy index decreased by 4.5%, and the food index increased by 3.3% over the last year.
On the earnings front, real average weekly earnings experienced a 0.1% MoM decline in October. However, real average hourly earnings rose by 0.2% on a monthly basis. On a YoY basis, real average hourly earnings increased by 0.8% in October. Compared to the same period a year earlier, real average weekly earnings were down by $0.11, amounting to $379.11.
Fed Unlikely to Hike in December and January
According to CME’s FedWatch Tool, the Fed is now 99.7% likely to keep its benchmark rate unchanged at the upcoming meeting in December. Similarly, the market is pricing just a 4% probability that the Fed will hike in January.
Overall, the market now sees almost less than a 10% chance the central bank will hike its policy rate any higher than the current 5.25%-5.50% range.
"In an environment where the market starts to play with the change of the rate cycle discount while central banks are still pushing back against any notion of rate cuts, more rates volatility is to be expected," the ING analysts said in a report.
As the chances of the Fed further hiking fall, the market is now shifting its focus toward expected rate cuts in the second part of the year as U.S. economy growth slows. Swiss banking giant UBS sees the Fed cutting rates by as much as 275 basis points in 2024.
According to UBS’ 3-year outlook starting from 2024, the bank sees existing headwinds persisting beyond 2023.
The bank's economists suggested that "fewer of the supports for growth that enabled 2023 to overcome those obstacles will continue in 2024."
Hence, the Fed will be forced to cut rates “first to prevent the nominal funds rate from becoming increasingly restrictive as inflation falls, and later in the year to stem the economic weakening,” UBS economists wrote.
Despite the most aggressive rate-hiking cycle since the 1980s, real GDP expanded by 2.9% over the year ending the third quarter. However, UBS anticipates a contraction of the economy by half a percentage point in the middle of the next year.
The Switzerland-based bank expects annual GDP growth to slow significantly to just 0.3% in 2024, coupled with a rise in unemployment to nearly 5% by the end of that year.
“With that added disinflationary impulse, we expect monetary policy easing next year to drive recovery in 2025, pushing GDP growth back up to roughly 2-1/2%, limiting the peak in the unemployment rate to 5.2% in early 2025. We forecast some slowing in 2026, in part due to projected fiscal consolidation.”
Summary
U.S. stocks and Treasuries rallied in response to the release of the CPI report for October, which showed a slower-than-expected pace of inflation last month. This outcome reinforced the market's perception that the Federal Reserve is unlikely to implement further interest rate hikes. The core CPI, which excludes volatile food and energy components, rose by 0.2% in October from the previous month, falling below the consensus of 0.3%.
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Shane Neagle is the EIC of The Tokenist. Check out The Tokenist’s free newsletter, Five Minute Finance, for weekly analysis of the biggest trends in finance and technology.