Heat Wave

A hotter-than-expected US inflation report has shifted markets toward a more hawkish Federal Reserve outlook and supported the US dollar.

• October headline CPI rose 0.4% month on month versus a 0.3% consensus, while core CPI increased 0.3% for the third consecutive month against expectations of 0.2%.
• Fed funds futures priced up to a 15% probability of a 50-basis-point rate increase at the December 9 meeting, moving the debate from a hold versus a 25-basis-point hike to the size of a potential increase.
• Dallas Fed President Lorie Logan said the FOMC needed at least two additional 25-basis-point increases and could tighten more rapidly during the winter.
• The real fed funds rate stood at 0.78%, below the estimated neutral real-rate range of 1.00% to 1.85%, which Logan and Kansas City Fed President Jeff Schmid viewed as evidence that policy remained accommodative.
• Real personal income excluding transfers fell 0.2% over the three months to September, while October nominal hourly earnings rose 0.4%, matching headline CPI and weakening the consumer spending outlook.

Takeaway: Persistent inflation and a still-accommodative real policy rate favor further Fed tightening, supporting the dollar and pressuring short-dated Treasuries, while weak real income growth creates a downside risk for consumption.