Did The Drop In CPI Inflation Impact The Outlook For Interest Rates?

The U.S. Federal Reserve recently raised its target Fed funds rate by 0.75% for the fourth time in five months as it attempts to get inflation under control.

Investors wondering if the Fed will pull the trigger on a fifth 0.75% hike at its next meeting in December got some key inflation data on Thursday morning suggesting the Fed may dial back the pace of its tightening.

The Labor Department reported the consumer price index (CPI) gained 7.7% in October, down from an 8.2% increase in September. In response to the cooler inflation number, the bond market is now pricing in only a 19.4% chance of another 0.75% rate hike in December, according to CME Group. Just one week ago, the market was pricing in a 38.5% chance of a 0.75% rate hike.

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DataTrek co-founder Nicholas Colas said the 5.5% rally for the SPDR S&P 500 ETF Trust (NYSE: SPY) on Thursday was triggered by the CPI reading giving investors a more optimistic outlook on inflation and interest rates.

"Futures expect the Fed to keep nudging rates higher in December 2022 and into Q1 2023, but now think the FOMC will likely be easing in the back half of next year," Colas said.

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More Rate Hikes Coming: While the chances of another 0.75% rate hike have fallen, the market is still pricing in a 100% chance of at least a 0.5% rate hike in December. Investors are also still expecting interest rates to continue to rise through at least the first quarter of next year.

The market is now pricing in a 33.8% chance the fed funds target rate range will be 5% to 5.25% or higher by March 2023. A week ago, those chances were 62.8%.

Bank of America economist Michael Gapen said Thursday that he still anticipates the Fed will not stop raising rates until it reaches the 5% to 5.25% range.

"In terms of our outlook for the Fed, today’s report is consistent with our view that they will downshift the pace of hikes [to] 50bp in December from 75bps. The labor market remains the key determinant of the terminal rate, in our view," Gapen said.

Benzinga’s Take: Falling inflation rates are certainly good news, but interest rates will most certainly remain elevated until inflation drops back down near the Fed's long-term target rate of 2%.

Thursday's bullish action in the S&P 500 is a knee-jerk relief rally, but it may still be challenging for the S&P 500 to make new all-time highs anytime soon.

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