As CPI Dips, Investors Are More Optimistic than the Fed on Rates

With the Fed meeting on Wednesday, the futures market continues to believe the central bank will ease soon. Perhaps unwisely, says LPL.


No doubt the slowing of inflation growth in November was good news, with the Consumer Price Index decelerating to a 7.1% annual pace from 7.7% for October. (The new reading was lower than economists’ projection of 7.3% for November.)

 

The stock market loved the news, with the S&P 500 closing up 0.73%, amid hopes that the Federal Reserve’s rate-hiking campaign is peaking or soon will. But the market may be setting itself up for an unpleasant surprise, by LPL Financial’s estimation.

 

There’s a big divergence between what investors, namely those in the futures market, expect and Fed members’ projections, as seen in the so-called dot plots of members’ predictions. The last one, at the end of September, showed an average 4.4% on the federal funds rate, and 4.6% by the end of 2023. (The Fed will issue a new one Wednesday.)

 

But the futures market believes, as of Tuesday, that the benchmark rate will end this year at slightly below the Fed’s number and stay there next year, notes Lawrence Gillum, fixed income strategist for LPL, in a research paper. He anticipates that the December dot plots will show the rate topping out at around 5% at some point next year.

 

All this could mean another Charlie Brown-and-the-football moment for stocks, if Fed Chair Jerome Powell sounds hawkish on Wednesday. “Markets have rallied three times this year on the expectation of a more accommodative Fed,” Gillum writes. Those rallies ended “when expectations for Fed moderation proved too early.”

 

But at least the stock market had a joyous time Tuesday, CPI day, although the closing price was far down from the morning surge, as investors realized they may have gotten ahead of themselves.

 

On December CPI days since 1999, a surprisingly lower-than-projected inflation number resulted in an average S&P 500 gain of 0.13%, according to Bespoke Investment Group. Nothing special. So consider Tuesday’s performance a gift, if only one that’s briefly enjoyed.

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