Inflation data raises doubts about whether Fed will ‘stay the course’: Morning Brief

Stocks and bonds had an especially bullish reaction to new data out Thursday showing that inflation continues to moderate after reaching a 40-year high over the summer.

The Dow (^DJI), Nasdaq (^IXIC), S&P 500 (^GSPC) and Russell 2000 (^RUT) each had their best day since the 2020 pandemic lows. The 5- and 10-year Treasury Notes (^FVX^TNX) saw their biggest one-day drop in yields since then-Fed Chair Ben Bernanke ramped up quantitative easing back in March 2009.

A casual observer could be forgiven for thinking the Fed has whipped inflation. While the U.S. is far from its 2% inflation goal, inflation eased more than expected last month. The headline Consumer Price Index rose 0.4% in October versus expectations of a 0.6% gain, while the year-over-year measurement ticked down to 7.7% from 7.9%. Taking out food and energy, core inflation also rose in October, but less than expected.

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Will this be enough for Fed Chair Jay Powell to change his tune and slow the pace of interest rate hikes? Echoes of a “Powell pivot” could be heard across the Twitter-verse as stocks rocketed higher across every sector and industry. Although inflation remains stubbornly high, the better-than-feared CPI prints inspired some investors to start taking risks again.

Optimism throughout 2022 have fueled outsized market moves such as these. So far, market participants have judged incorrectly, as new lows in the major indices have followed every major rally.

Powell, for his part, has pledged to raise interest rates, even if it hurts parts of the economy. At his last press conference, Powell flat-out said he’s more concerned with “entrenched” inflation than he is with the risks of the Fed continuing on its hawkish path — the main danger being a recession.

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That resolve hasn’t stopped investors from hoping that the Fed will stop rate hikes sooner rather than later.

Alfonso “Alf” Peccatiello, founder and CEO of The Macro Compass, told Yahoo Finance on Thursday that bonds are pricing in a lower terminal Fed Funds rate — or the rate at which the Fed stops hiking. He also highlighted that bond volatility is “dropping like a stone” and credit spreads have tightened. These signs all nudge investors to take on more risk, at least in the short-term.

“With this inflation print,” Peccatiello said, investors “believe less and less the Fed will stay the course.”

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