Markets Now Expect Another +200 bp of Rate Hikes After Disappointing CPI Report

The stock market reacted very bearishly to today’s CPI report, which was mildly above expectations. The Nasdaq 100 Stock Index ($IUXX) (QQQ) is down more than -4% today. 

Today’s U.S. Aug CPI report of +0.1% m/m and +8.3% y/y was mildly stronger than expectations of -0.1% m/m and +8.1% y/y.  Meanwhile, today’s U.S. Aug core CPI report of +0.6% m/m and +6.3% y/y was stronger than expectations of +0.3% m/m and +6.1% y/y. 

While today’s CPI report was stronger than expected, the CPI figures remained below their recent peak and did not post new highs.  That keeps alive hopes that the headline and core CPI figures have already peaked and will still move lower through year-end.  Specifically, today’s Aug CPI report of +8.3% y/y remained 0.8 points below June’s 40-year peak of +9.1%, and today’s core CPI report of +6.3% y/y remained 0.2 points below March’s 40-year peak of +6.5% y/y.

Stock investors had apparently convinced themselves that the Fed was nearly done with its rate-hike regime. However, today’s CPI report dashed those hopes and instead suggested that the Fed will continue its aggressive rate-hike regime.

In response to today’s CPI report, the markets have added expectations for another +25 bp rate hike in early 2023.  Specifically, the markets are now expecting the federal funds rate to peak at 4.31% in April 2023, before easing to 3.83% by the end of 2023, according to the federal funds futures market.

The markets are therefore expecting the Fed to raise its funds rate target by a total of two more percentage points to 4.31% by April 2023 from the current effective federal funds rate of 2.33%.  Before today’s CPI report, the markets were expecting the funds rate to peak at 4.02% in April 2023, for an overall rate hike of +169 bp.

Regarding the short-term outlook, the markets are now fully discounting a +75 bp rate hike at next week’s FOMC meeting and are even discounting a small 25% chance of a +100 bp rate hike. 

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