- Investors on Tuesday stepped up bets the Federal Reserve will continue to slash the size of rate hikes after 2022.
- The CME FedWatch tool showed a 57.3% probability of a rate increase of 25 basis points in February compared with 35.1% a day earlier.
With November inflation cooling by more than expected, investors on Tuesday stepped up bets that the Federal Reserve will continue to slash the size of rate hikes in early 2023.
The CME FedWatch tool showed a 57.3% probability of a rate increase of 25 basis points at the February 1, 2023, policy decision compared with a 35.1% probability a day earlier.
A rate hike of 25 basis points at the Federal Open Market Committee's first meeting of next year would leave the fed funds rate in a 4.5% to 4.75% range.
Investors also pushed up the odds the Fed will pause its rate hikes with the March 22 decision, propelled to 24.4% from 9.2% a day prior. But futures pricing also reflected expectations of increases between 25 and 50 basis points.
The moves came after the Labor Department said the Consumer Price Index rose to 7.1% year over year on the headline level as price gains for food and shelter eased. The reading was less than the 7.3% estimated in a Bloomberg survey of economists and the lowest since December 2021 when inflation stood at 7%. Core CPI, which strips out volatile food and energy prices, rose 6% year-over-year, below the 6.1% projection.
"If inflation continues to fall, the Fed will probably be able to start reducing interest rates in the fall of 2023. But that process is expected to be very gradual since the Fed doesn't want to be caught offsides by a too-rapid reacceleration of the economy fueling a rebound of inflation," Bill Adams, chief economist at Comerica Bank, wrote in a note Tuesday.
The November inflation report arrived a day before the Federal Open Market Committee is expected to deliver its seventh and final rate increase of 2022.
"With the Fed likely to raise their benchmark interest rate half a percent this week, then probably by a quarter percent at the following two meetings, the Fed's short-term interest rate will probably be above CPI inflation by then," said Adams. "That will probably be enough for the Fed to pause their rate hike cycle with the federal funds rate target at a range of 4.75%-to-5.00%."
Stocks surged after the November data while Treasury yields fell and the US dollar dropped against some rival fiat currencies. The 2-year yield, sensitive to Fed policy moves, sank 20 basis points to 4.2%. The US Dollar Index fell to its lowest in nearly six months, losing more than 1% to hit 103.60. Among equities, the Nasdaq Composite paced advances by rising 3% during Tuesday's session.
"All the signs have been pointing toward slower inflation and now we have the confirmation," David Russell, vice president of market intelligence at trading platform TradeStation, said in a note. "This is a good sign for the market but isn't likely to change the Fed's outlook much. They're still worried about high wages and housing costs."