Despite cool inflation, don’t expect rate cuts

The Marriner S. Eccles Federal Reserve building during a renovation in Washington, DC, US, on Tuesday, Oct. 24, 2023.

Valerie Plesch| Bloomberg | Getty Images

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What you need to know today

Back in the green
U.S. stocks ticked up Wednesday as another report showed inflation’s cooling. Despite that, Treasury yields rose. The pan-European Stoxx 600 index added 0.42%. Britain’s FTSE 100 climbed 0.62%, on encouraging inflation news in the U.K., to turn positive for the year. Separately, Siemens Energy jumped 8.78% after securing guarantees from the German government.

More good news on inflation
U.K.’s consumer price index plunged from 6.7% in September to 4.6% in October on an annual basis, though it remained the same month on month. Both figures were below economists’ estimates. Core CPI, which excludes food, energy, alcohol and tobacco prices, rose 5.7% for the year. With those numbers, it’s likely the Bank of England will continue leaving interest rates unchanged.

‘Planet Earth is big enough’
U.S. President Joe Biden met Chinese President Xi Jinping yesterday on the sidelines of the Asia-Pacific Economic Cooperation conference. The two leaders struck a conciliatory tone at the start of the summit. “We have to ensure that competition does not veer into conflict,” Biden said. And Xi, in his opening remarks, said, “Planet Earth is big enough for the two countries to succeed.”

AT1 bond demand ‘a signal’
UBS began selling additional tier one bonds last week. AT1 bonds were wiped out when UBS was forced to take over Credit Suisse earlier this year, causing controversy among bondholders. Still, there was “incredible” market demand for them, said CEO Sergio Ermotti, which “is a signal to the Swiss financial system” that confidence is being restored.

[PRO] Where will cash go?
With the high interest rates and bond yields in recent months, money market funds and Treasurys have attracted investors’ cash, sucking them away from stocks. But with October’s CPI coming in so cool that analysts are comfortable declaring a soft landing, stocks have begun rallying again. What, then, happens to all the cash parked in those funds?

The bottom line

After a very encouraging consumer price index reading on Tuesday, we have more evidence that inflation’s truly cooling.

Wholesale prices in October, as measured by the producer price index, fell 0.5% for the month against the expected 0.1% increase. That’s the biggest decline in more than three years. When producer prices fall, it takes a while for those lower prices to seep into the general consumer economy, so it’s plausible we’ll see CPI continue dropping in the months ahead.

Major U.S. indexes rose — slightly — on that encouraging news. The S&P 500 increased 0.16% and the Nasdaq Composite edged up 0.07%. The Dow Jones Industrial Average gained 0.47% for its fourth consecutive winning session.

The stock market rally over the past two days, it seems, was fueled by investors’ expectations that lower inflation readings will prompt the Federal Reserve to cut rates sooner rather than later. Investors think there’s a 31% chance the Fed will slash rates by a full percentage point by the end of next year, according to the CME FedWatch tool.

But that flurry of cuts is two times as aggressive as the timeline the Fed itself penciled in two months ago, noted CNBC’s Jeff Cox. And that, to put it mildly, “may be at least a tad optimistic,” Cox wrote.

Investor optimism, ironically, may be counterproductive as well. Expectations of a rate cut forced down Treasury yields Tuesday (though they rose again yesterday). Treasury yields tend to serve as the benchmark for loans and other assets, so when they drop, financial conditions loosen — exactly what the Fed doesn’t want to see.

“Financial conditions have eased considerably as markets project the end of Fed rate hikes, perhaps not the perfect underpinning for a Fed that professes to keeping rates higher for longer,” said Quincy Krosby, chief global strategist at LPL Financial.

Indeed, “this is at least the 7th time in this cycle that markets [anticipate] … a potential dovish pivot,” wrote Deutsche Bank macro strategist Henry Allen. (Spoiler alert: Investors have, without exception, been disappointed the previous times as the Fed refused to budge.)

In short: While it’s undeniable inflation’s dropping, there’s no guarantee rates will fall in tandem. It might be better to be pleasantly surprised than to be disappointed.

— CNBC’s Jeff Cox contributed to this report.

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