Stocks and bonds embarked on a furious rally following the October CPI release which came in at 7.7% which was below consensus expectations of 7.9%. Across the board, inflation figures came in softer than expected as the softness in commodities, goods, transport, and bottlenecks seem to be working its way through the system.
The major takeaway is that inflation likely peaked this summer, and there is hope that we could get to the Fed's threshold for pausing which is a negative reading in monthly core inflation or 3 sequential declines in readings. It's meaningful for the real economy as lower inflation means lower rates which would result in lower borrowing costs and boost battered industries like housing. And, it's also a powerful catalyst for sectors that have been crushed by rising rates like tech and housing. For stocks, it also should boost margins and increase consumer confidence.
On a monthly basis, CPI was up 0.4% which was below estimates of a 0.6% monthly increase. Core CPI was up 0.3% on a monthly basis and 6.3% annually. This was also below estimates of a 0.5% and 6.5% increase.
The biggest factor in inflation falling short of expectations was a 2.4% decline in used car prices. Other contributors were a 0.7% drop in apparel and a 0.6% decline in medical care services.
We are starting to see some of the extremes that are attributable to the pandemic moderate. Prominent examples are freight pricing, used vehicles, and chips. This has been happening for a few months but is just starting to show up in the data. And, it's quite crucial whether categories like services inflation, wages, and rents continue trending higher or also moderate.
Housing costs were up 0.8% on a monthly basis which is the largest gain since 1990. Fuel prices also increased by 19.8% on a monthly basis.
Despite the positive report, markets may be too quick to assume that a pivot is coming with regard to Fed policy. Cost of living continues to rise at a faster pace than wages. On an annual basis, real average hourly earnings were down 2.8% and down 0.1% on a monthly basis.
Following the CPI release, there was some movement in terms of fed futures. Odds of a 50 basis point hike at the December meeting increased to 80% from 57%, while odds of another 75 basis point hike declined. However, there was no change in the Fed's terminal rate which continues to hover around 5% in Q1 of 2023.