The markets got the inflation report they were looking for with the July CPI.
The BLS reported on Wednesday a flat headline number that took the annual rate down to 8.5% and sent stocks ( SPY ) ( QQQ ) and bonds ( SHY ) ( NYSEARCA: TBT ) ( TLT ) higher.
The market is now pricing in more than a 60% chance of the Fed hiking rates by 50 basis points next month, down from 75 before the CPI hit. The odds are for another 50 in November, while December is wavering between 25 and no hike at all.
But Fed rhetoric is likely to stay hawkish through to Jackson Hole and the up to the September FOMC decision. Chicago Fed President Charles Evans said yesterday he still expects to be hiking in 2023 .
This CPI won't prompt a dovish pivot for the Fed, says Steve Englander, head of North American and G10 FX strategy at Standard Chartered.
One month's disinflation is far from definitive, is not yet broadly based and the Fed wants to make suer the output gap is widening, Englander and head of research Sarah Hewin wrote in a note.
"In our view, a more subtle transformation is taking place," Englander said. "Comments by FOMC participants indicate that the FOMC is very uncomfortable with market pricing of early rate cuts next year. So are we. If the slowdown is sudden enough to justify the quick cuts that markets price in, it will probably be visible to the FOMC as well and the response will likely be to slow the pace of hiking sooner than expected."
"The caveat is that the pause will likely last longer than now priced in, be conditional on ongoing progress towards the 2% goal and explicitly leave open the possibility of 2023 hikes if the disinflation path is too shallow," he added. "We think this message of stretching out hikes and trying to steepen the short term rates curve will be part of the FOMC’s signaling in the coming months."
"The advantage is that the FOMC will be able to better assess the impact of hikes to date and how much further to raise policy rates. Also, it is probably less politically controversial to hold policy relatively tight in 2023 and ease subsequently if justified, than to follow the currently priced market easing path in 2023 and then reverse if disinflation is inadequate."
But will the markets listen?
The stock market barely budged on Evans' comments Wednesday and picked up steam through afternoon trading.
"With signals around the fed funds rate being its main communication tool, one can reasonably question whether more hawkish comments have the power to move long-term yields much," ING strategists wrote. "Even with a Fed signaling that it will rely on backward-looking inflation data (which itself is a lagging indicator of the economic cycle), markets need to price what the Fed’s decisions will be months, and even years in advance."
"Fast forward one year, with much slower economic growth, inflation on its way back to target, and fed funds way above neutral, we don’t blame the curve from pricing rate cuts," the added. "Today’s Fed doesn’t need to acknowledge that for the curve to price it with a high degree of conviction."
See why Jefferies says the Fed has achieved the central banking Holy Grail .
For further details see:
Don't expect peak inflation to silence the Fed's hawkish squawks