Consumer prices handily beat expectations again but to the downside in October, with headline CPI advancing a still strong 0.4% m/m. Similarly, the core index fell significantly below consensus expectations (TD: 0.4%, consensus: 0.5%), rising at a still above-trend 0.3% m/m pace, with slowing reflecting more modest, but still elevated rents and OER inflation, coupled with a nice retreat in core goods prices.
In our view, the October CPI report should cement expectations for a 50bp rate increase at the December FOMC meeting, in line with our forecast. At this stage, there is no longer a need to front-load tightening and the Fed now has room to shift to a steadier hiking pace going forward.
Rates: Treasury yields fell sharply and the curve steepened as the market priced in a less hawkish Fed. We think that the market may be getting a little ahead of itself as the Fed will need more reports to confirm that inflation is slowing before it can signal a pause. We remain long 10y Treasuries and in SFRH3-H5 flatteners.
FX: One print does not make a trend, but it sure does help. Given where we are in the tightening cycle, it is natural for the market to think about the end-point is near. That introduces an asymmetry in the USD around data/Fed. We have noted a USD correlation switch to easing priced into the curve. Positioning ahead of this meeting showed a notable reduction in USD longs across several pairs. This will likely extend in the yen. USDJPY has put in good work to form a top and downside pressure is likely persist as yen has been oversold on crosses. We like CADJPY downside.
The Fed’s nowcasting model is still printing above 0.4 per month:
Two very different scenarios present themselves. Either sticky inflation combined with this sudden easing in the FCI will keep the Fed on track for more (less steep) tightening and this is another, larger, bear market bounce for everything.
Or, US inflation will keep falling and a US soft landing becomes a distinct possibility meaning DXY has topped and AUD bottomed.
I am still leaning toward the former as the base case but today is the first time in a long while that I can see a not unreasonable path to the latter.
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