Tuesday's Inflation Report Seen As A Turning Point in The War On Inflation

Tuesday’s report on the consumer price index marked a turning point in the Fed’s war against inflation: More experts began talking about when the Federal Reserve will cut interest rates, rather than how high it will raise them.

Market expectations for another Fed rate hike plummeted Tuesday morning after a highly anticipated report on inflation showed consumer prices rose 3.2% over the year in October, down sharply from a 3.7% annual inflation rate in September. 

As of Tuesday afternoon, traders were pricing in a 0.2% chance that the Fed’s policy-setting body would raise interest rates when it next meets in December. That’s down from 14.5% on Monday, and 28.8% a month ago, according to the CME Group’s FedWatch tool, which forecasts rate hikes based on fed futures trading data.

In fact, the market odds of a rate hike by the following meeting in January also fell from 23% to 0.2%. And the projected odds for any rate hike after that: 0.1%.

“The prospect of a final rate hike is looking pretty slim right now,” James Knightley, chief international economist at ING, said in an email.

Even before Tuesday’s inflation report, many economists had thought the Fed had already won its war on inflation and put it on a path firmly toward its goal of a 2% annual rate. 

Since March 2022, the central bank has raised its benchmark fed funds rate 11 times to a 22-year high of 5.25%-5.50%. That’s pushed up interest rates on all kinds of credit for individuals and businesses, including mortgages, credit cards, and auto loans, making borrowing far costlier and more difficult. It’s also made saving more attractive, with banks now offering the highest rates for certificates of deposit and high-yield savings accounts in decades.

The idea is to discourage people from spending money and businesses from hiring and expanding too much, allowing supply and demand to rebalance. That, in theory, would push down the rampant inflation that took hold as the economy reopened from the pandemic in late 2021. 

While Fed officials have recently emphasized their willingness to raise rates again if inflation bounces back, more experts are saying they won’t have to.

“It would now take a horrific CPI report for November, and likely a big rebound in payrolls too, in order to trigger a final hike,” wrote Ian Shepherdson, chief economist at Pantheon Macroeconomics, in a commentary. “Bumps in the road are still likely. But the combination of a full reversal of pandemic-driven supply-side problems, and the likely moderation in demand growth, means that the conditions for sustained disinflation are in place.”

There are a number of factors now working against inflation that had alarmingly spiked in 2021 and 2022. The supply chain disruptions that helped push inflation to a 40-year high last summer are gone. Car prices are falling, and high mortgage rates have smothered the frenzied pandemic-era housing market, so home prices are rising at a moderate pace rather than skyrocketing like they were before. While workers remain in high demand amid plentiful jobs and ongoing labor shortages, wage increases have slowed down, easing fears of an out-of-control wage-price spiral setting in.

With another rate hike now seeming remote, economists are paying more attention to when the Fed might reverse course and start cutting rates to prevent the economy from falling into a recession.

“We suspect the debate next year will focus squarely on when rate cuts and the end of quantitative tightening will occur,” Sarah House and Michael Pugliese, economists at Wells Fargo Securities, said in a commentary. 

According to the CME's FedWatch tool, traders are now pricing in nearly a 33% chance that the Fed will start cutting rates in March, up from the 10.5% probability priced in on Monday.