Inflation vs. Fed: Traders Brace for Impact

November CPI Could Upend December Rate Cut Expectations

Traders in fed-funds futures currently place an 85% chance on the Federal Reserve cutting rates by 25 basis points at its December policy meeting. This level of confidence aligns with historical norms during the Fed’s “blackout” period, when officials refrain from public comments on monetary policy ahead of a meeting.

As of Tuesday, market expectations for a December rate cut remain steady, supported by data from the CME FedWatch Tool. This optimism has fueled a strong stock market rally, with the S&P 500 and Nasdaq Composite reaching record highs last week and the Dow Jones Industrial Average crossing the 45,000 milestone for the first time.

Inflation Data Looms as a Potential Game-Changer

This week’s release of the November consumer price index (CPI) on Wednesday and producer price index (PPI) on Thursday could still shift market sentiment. Economists surveyed by The Wall Street Journal expect CPI to rise by 0.3% month-over-month for both headline and core readings. Year-over-year, headline inflation is forecasted to tick up to 2.7% from 2.6% in October, with core inflation steady at 3.3%.

A sharper-than-expected increase in CPI—such as a 0.4% monthly gain—could raise questions about the Fed’s plans, said Jay Hatfield, CEO of Infrastructure Capital Advisors. However, most analysts see little likelihood of such an outcome, given policymakers’ confidence that inflation is on track toward the 2% target.

Fed’s Gradual Approach and Market Sentiment

Minutes from the Fed’s November meeting highlighted officials’ preference for a more measured pace of rate cuts, with Chair Jerome Powell emphasizing the importance of avoiding undue haste. Although a December rate cut appears likely, the Fed may strike a “hawkish” tone, signaling slower rate reductions in the future.

Recent economic data has bolstered expectations for a December easing. November’s stronger-than-expected jobs report reinforced this view, and remarks from Fed officials, including Powell and Governor Christopher Waller, have not challenged the market’s outlook. Waller, in particular, indicated he supports a rate cut unless inflation data surprises significantly.

The Role of the Dot Plot

The December meeting will also include an updated Summary of Economic Projections, known as the dot plot, which outlines individual Fed officials’ rate forecasts. A projection showing only modest rate cuts in 2024 could help balance the more hawkish voices within the central bank, according to Hatfield.

Key Takeaways

With inflation data as the final major input before the December meeting, the market is poised for a rate cut. However, any significant surprise in the CPI could disrupt these expectations, underscoring the Fed’s delicate balancing act as it navigates its monetary policy path.