CPI & FedSpeak Raise Odds of 'Higher For Longer' Policy

Markets struggled to digest the US CPI report yesterday, with the (now customary?) cross-market whipsaw effect in full swing. Signs of inflation falling back to target are hard to come by, and ‘higher for longer’ interest rates are increasingly being priced into interest rate futures.

First up, a familiar pattern. The whipsaw effect around big data releases. Here’s the Nasdaq on a 1 minute chart.

Initially, the market tumbled as CPI came roughly in line with expectations of a hotter print. 0.5% monthly CPI vs 0.1% in December puts a big dent in the disinflationary narrative. However, the market subsequently rallied, then fell back again, until the Nasdaq cash session got underway and price rallied once more.

Volumes tend to pick up in the cash market. Some traders say that’s when the ‘true’ meaning of data releases can be established. However, the Nasdaq is still rangebound this morning even as markets continue to price in higher interest rates for longer, which may weigh on the tech/growth heavy stock index.

This graphic shows how expectations have shifted.

It looks more complicated than it is. The blue line is current pricing. The red line is how markets saw rates on the 16th of November 2022. The letters after ZQ represent the month. Counterintuitively, the lower the line, the higher the expected interest rate. Two things are very notable. Firstly, the expected peak Fed rate is now higher at 5.25% (100-94.75) in ZQQ3 (August). Perhaps more consequential is the pricing out of rate cuts.

If we take the red line as a guide, the market saw a peak rate of 4.92% in June followed by (almost) two 25 bps rate cuts to 4.43% by January 2024. Now, the market sees a peak of 5.25% and only 20bps of rate cuts to 5.05% by January 2024.

Hence, higher for longer…

Various Fed speakers affirmed that more rate hikes were likely and that the job wasn’t done yet.

Dallas Fed President Lorie Logan:

"We must remain prepared to continue rate increases for a longer period than previously anticipated, if such a path is necessary to respond to changes in the economic outlook or to offset any undesired easing in conditions"

New York Fed President John Williams was very clear too, saying:

"With the strength in the labour market, clearly there are risks that inflation stays higher for longer than expected or that we might need to raise rates higher"

He also suggested that a policy rate between 5% and 5.5% at the end of 2023 "seems to be the right kind of framing" for the outlook.

Deutsche Bank’s Macro team think it’s more likely to be at the higher end of that range:

"After yesterday's US inflation numbers DB have increased our US terminal rate forecast from 5.1% to 5.6% with two extra 25bps hikes in June and July”

The fate of many Young Unprofitable Companies (such as Shopify) could be decided as much by the interest rate path as any economic prospects.

It’s very hard to make a strong case for the Nasdaq to rally in a higher rate environment, but markets don’t always follow a rational path. Participants operate with different motivations across different time horizons.

Economic growth expectations are another key component to consider. Today’s US retail sales data will be closely-watched. Consensus looks for a 1.8% print.