September 15, 2022
Tuesday’s hotter than expected core CPI report has markets full priced for a 75bp hike with odds of a 100bp hike priced at ~25%. Fed’s decision to hike by 75bp or 100bp will likely be influenced by signaling in that a 100bp hike may only encourage those calling for a Fed pivot next year – something officials have recently tried to discourage. While next week’s policy decision is important, the key issue for markets is the pricing of terminal rate expectations, which now sit at ~4.45% with a handful of sell-side economists penciling in numbers north of 5%. Year-end ’22 rate expectations of ~4.23% are now running ahead of the 3.75-4% range used by the Fed’s most hawkish members. Also note that next week’s Fed meeting includes an updated Summary of Economic Projections (SEP) and an updated dot plot (Fed rate expectations). Since the last SEP was published in June, we’ve seen: 1) GDP track below the Fed’s median forecast: 2) the Unemployment Rate tracking with the forecast and; 3) headline PCE inflation run below the forecast. This data doesn’t point to an upward revision in the year-end ’22 median rate forecast which was 3.5% in June. Tuesday’s core CPI report showed rent (housing) and wages running ahead of expectations. Fed officials should understand that monetary policy operates with a lag, especially when it comes to housing and labor markets.