Morning Notes — CPI Scenarios

Realized inflation data matters most for markets and near-term Fed policy with Thursday’s release of October CPI scenarios in view.

CPI scenarios: Consensus is looking for October headline CPI to increase +0.7% MoM, taking the YoY rate to +8.0% from +7.8%. Core CPI is expected to slow to +0.5% MoM from +0.6% last month, which would leave the YoY rate unchanged at +6.6%. From an equity perspective, the downside scenario would be a YoY headline print above +8.4%. The probability of this happening is ~5% with the S&P 500 (SPX) selling off 5-6%. The other tail risk scenario would be headline CPI at or below +7.6% that would drive 10-year Treasury yields below 4% and take the SPX up +5-6%. We see ~30% probability for something in the 8.1%-8.3% range, driving the SPX down 2%-3%. The most likely scenario (~40% provability) would be a YoY rate that falls into the 7.9%-8% range, which could result in an SPX gain of 1%-1.5%. That leaves us with a 20% probability for something in the 7.7%-7.9% range with an associated 2.5%-3.5% rally in the SPX.

Bond yields: The technical setup for 10-year yields favors mean reversion to the 3.52-3.60% range.  If realized, this type of move could drive the SPX to ~4100. Getting there in the near-term likely requires a strong austerity message from a Republican controlled Congress or a big CPI miss on Thursday.

A new report from the San Francisco Fed claims monetary policy is a lot tighter than what’s implied in the current 4% Fed funds rate with an effective rate closer to 5.25%