Morning Notes — Rate Hikes and Inflation

Expectations: Consensus is looking for a 75bp hike and hawkish press conference where Powell stays focused on remaining inflation risks.  In addition to today’s rate hike, markets are also currently priced for 75bp in November and 50bp in December. Assuming a 75bp hike from today’s meeting, has Fed expectations priced for 4.50% by year-end. Essentially, consensus expectations are for the unrelenting ‘hike and hold’ messages to continue.  And equities have a bid this morning based on the passage of this meeting removing a large overhang.

Real yields: Forward earnings multiples will remain under pressure as long as real yields continue to rise.  Ten year real yields are now +118bp, which creates a significant headwind for Tech multiples in particular.  We see the potential for Tech to outperform when 10-year real yields cross below +56bp. Higher real yields are currently a function of higher 10-year nominal yields and mostly static 10-year inflation expectations.

Inflation: Higher ‘Owner’s Equivalent Rent’ (OER) was the single largest contributor to the hotter than expected August core CPI print. Using CPI weights, OER contributed +1.93 percentage points to the YoY increase in August core CPI with ‘Rent of Primary Resident’ adding another +0.67. It’s usually the case for monetary tightening to drive a ‘get it while you can’ consumer function before an ultimate peak. However, today’s decline in August median home prices suggest we’re already past the peak in the rent basket.  And the Zillow Observed Rent Index actually peaked at ~17% in February and is now ~12% in August vs. ~4% pre-pandemic. The secondary driver of Core inflation has been vehicle prices. The Manheim Used Vehicle Index fell -4% in August, is down -2.3% month-to-date through 9/15 and tends to lead official CPI data by 1-3 months.