Macro Insights: A softer US CPI expectation does not materially change the Fed path

Markets face a big test ahead with the release of US inflation figures later today. While some may still be hoping for a Fed pivot if we see a softer print, it is probably time for them to wake up and smell the coffee.

There is no doubt that some indicators are pointing towards some easing of price pressures. That has to happen – maybe today, maybe in another 1-2 months. This month, we have had the price paid component of ISM manufacturing dip below 50, which marks the dividing line between expansion and contraction. Still, ISM services hinted at further gains in prices for the services sector, which continue to point towards stickier and broader price pressures. Meanwhile, commodity prices have once again remained in a range in October, while China reopening has not materialised in any substantial way. The wave of tech layoffs that we have seen over the last few weeks also suggests there will be some downward pressure on wages in the coming months.

Expectations take this into account, with the headline CPI print for October seen softer at 7.9% YoY from 8.2% YoY previously. Core is expected at 6.5% YoY and 0.5% MoM, still way too high from the 0.2% MoM levels needed to bring inflation close to the Fed’s 2% target. However, any softness, if seen today, is unlikely to change the Fed path.

The Fed has already communicated a downshift in its rate hike trajectory without exiting its hawkish bent. Could there be room for them to pursue more dovishness despite inflation being still far from its target? I would doubt that. December Fed rate pricing is currently closer to a 50bps rate hike, there is no way we will get a smaller hike than that. A poor showing of the Republicans in the US midterms has also given the Fed more ammunition to remain focused on inflation, rather than the markets.

The biggest risk, therefore, is still a beat of expectations, as that could mean further higher terminal rate pricing and a move towards 75bps in terms of December rate hike pricing. An upside surprise in inflation and a move in US 2-year yields back towards 4.7% could be USD positive and move the yield-sensitive Japanese yen. But its better to still be wary of too much pressure on the USD, beyond a knee-jerk reaction, even if we see a softer CPI print because we are going into today’s release with a very weak risk sentiment on the back of the crypto turmoil and the tech sector layoffs sounding a louder alarm on recession concerns, suggesting the safe-haven reputation of the US dollar may come into play.

A reaction in equities will likely remain worth noting. A core print of below 0.5% could spark a relief rally, but eventually the focus will turn back to Fed’s terminal rate target which will still be above 5%, mounting earnings pressures and liquidity woes stemming from the crypto crash and other financial risks in the markets. Also, a number of Fed officials are scheduled to speak after the CPI release, including the Fed's Daly, Mester and George – and they would potentially be ready to up their hawkish stance if we see a CPI miss. But a higher print, together with the risk mood we are in, can be quite painful for equities. We also have a 30Y treasury auction due, and such long duration supply could well extend a push towards higher yields.