We're less than two weeks now to the next FOMC meeting and after yesterday's over 9% US consumer inflation print, markets have moved to price in a 100 bps rate move later this month. Fed fund futures show that we're roughly ~82% there:
What a difference 24 hours make and we are also seeing Fed policymakers not shy away from the possibility of such a move. The comments from Bostic and Barkin yesterday highlights that shift in thinking.
But while markets are focused on a plausible 100 bps rate hike by the Fed in two weeks' time, I would argue that it isn't the most notable thing or reaction to the inflation numbers yesterday. At this point, headline or core doesn't really matter as it is evident that inflation pressures are broad-based and more sticky than anticipated.
Sure, as gasoline prices come down, we could see price pressures moderate a little in the months ahead but the takeaway is that the Fed is struggling to rein in the surge in inflation. One can say that they were behind the curve but then again, monetary policy is not exactly best suited to deal with the factors causing the jump in prices.
The question now is that as the Fed is frontloading rate hikes, how will all of that play to the economic circumstances in the US? The more pertinent issue is whether or not we will have a "soft" or "hard landing". I would say the answer to that is relative. While we are not likely to see an extremely sharp recession, a prolonged period of slow growth and tougher economic conditions is the most likely trajectory in the next year or two at least.
And the market reaction exemplifies that. It's not about rate hikes anymore. 75 bps or 100 bps hardly matters all too much. Instead, it is all about where we are seeing the terminal rate by the Fed and where the shift in monetary policy is going to occur.
Based on the moves yesterday, it is clear that markets are bracing for the Fed to hike aggressively through to year-end with a terminal rate around 3.50% to 4.00%. But beyond that, there is less certainty and we are already seeing rate cut calls come into play as early as the middle of next year.
The latter arguably implies a cap on bond yields but we are not yet heading back in the other direction. As long as the focus and narrative remains on tighter policy, 10-year Treasury yields around 3% seems to be the "sweet spot" where traders are liking things to be right now.
Considering the more challenging economic backdrop for Europe and the UK (and Japan still not moving on policy divergence), that makes the US - and the dollar - a rather attractive proposition still for the time being.
