There was relief in the markets today after the July U.S. CPI report came in weaker than expected. The Nasdaq 100 is up +2.2%, and the 10-year T-note yield is down by -5 bp. The 2-year T-note yield is down by a dramatic -15 bp.
The markets today significantly scaled back expectations for Fed tightening over the coming months. The October federal funds futures contract (ZQV22)  today is down by -8.5 bp on a yield basis at 2.93%, reflecting about 40% odds for a 75 bp rate hike at the FOMC’s next meeting on September 20-21. Before today’s report, the markets were discounting a much higher chance of a 75 bp rate hike. The markets are discounting a 100% chance of at least a 50 bp rate hike at the Sep 20-21 FOMC meeting.
Also, the market is now predicting a peak of 3.52% in the federal funds rate by March 2023, down by -10 bp from expectations before today’s CPI report of a peak of 3.62%.
The Dec 2023 federal funds futures contract today is sharply lower by -17 bp on a yield basis, meaning the market is now expecting 17 bp less Fed tightening by the end of 2023 than it was before today’s CPI report.
The markets are now expecting an overall +119 bp rate hike to a peak of 3.52% by March 2023 from the current effective federal funds rate of 2.33%. The markets are then expecting roughly a -50 bp rate cut in the second half of 2023 and a further -50 bp rate hike by early 2025, bringing the federal funds rate close to the Fed’s view of a neutral funds rate of 2.50%.Â
The jury remains out on whether U.S. inflation has actually peaked. However, today’s CPI report was a step in the right direction since the headline CPI eased from June’s 40-year peak and the core CPI remained 0.6 points below its peak that was previously reached in March.
The markets have already gotten past any inflation hysteria. The 10-year breakeven inflation expectations rate is currently trading at 2.43%, only moderately above the Fed’s long-term target of +2%. The breakeven rate is down by about 1/2 percentage point from the peak of 3.08% posted this past spring when the core CPI peaked.
The markets continue to believe that the Fed will be successful in bringing inflation back down to more reasonable levels and therefore 10-year inflation expectations remain anchored below 2.5%.Â
The breakeven rate measures the difference between the nominal and TIPS 10-year Treasury notes and reflects market expectations for the average inflation rate over the next 10 years.
Looking at the detail in the CPI report, the July CPI report of unchanged m/m and +8.5% y/y was weaker than expectations of +0.2% m/m and +8.7% y/y. The July CPI eased from June’s report of +1.3% m/m and +9.1% y/y. Meanwhile, the July core CPI report of +0.3% m/m and +5.9% y/y was weaker than expectations of +0.5% m/m and +6.1%. The July core CPI report compared favorably with June’s report of +0.7% m/m and +5.9% y/y.
On a year-on-year basis, today’s July CPI report of +8.7% y/y was down by 0.4 points from June’s 40-year peak of +9.1% y/y. The July core CPI of +5.9% y/y was unchanged from June and was 0.6 points below the 40-year peak of +6.5% y/y posted earlier this year in March.
More Stock Market News from Barchart
/Semiconductor%20by%20Gorodenkoff%20via%20Shutterstock.jpg)
/An%20image%20of%20a%20Tesla%20humanoid%20robot%20in%20front%20of%20the%20company%20logo%20Around%20the%20World%20Photos%20via%20Shutterstock.jpg)
