Could the Fed hike by 50bps in December?

A hot CPI print for October has increased the chance of a rate hike from the Federal Reserve in December. There is now an 86% chance of a 25 bp hike, and a 13% chance of a 50 bp hike after headline CPI rose by 0.4% last month, higher than the 0.3% expected by the market. 

This data comes after comments from FOMC member Chris Waller who said earlier this morning that he supports a 25bp hike next month, and may even vote for a 50 bp hike if the October inflation print suggests that inflation is becoming sticky. 

Both headline and core price growth was stronger than expected last month, which makes it hard for the Fed not to hike rates. The biggest drivers of inflation included energy, which rose 0.7% on the month, food, which rose by 0.5% and shelter costs, which also rose by 0.3%. 

Gasoline prices rose by 1%, and the only sectors that saw declines in prices last month were used cars and trucks and utility service charges. 

The increase in the shelter price accounted for 30% of the rise in CPI last month, which is a clear sign that US inflation is becoming embedded. This increases the chance of a 50 bp hike, as it suggests the Fed made a misstep when they held rates steady last month. 

There is still nearly a month to go before the next FOMC meeting, and the market will get another NFP report by then, and we will need to see if the downside pressure on oil prices continues. Since the start of November, US WTI crude oil prices have fallen $18 per barrel and remain at their lowest level since September. 

This does not change today’s report, but it could slow price growth in the future. Although the November CPI report is not released until the day after the FOMC meeting, the Fed should get a preview of November CPI at their December meeting. If the new Fed chair Kevin Warsh is correct, and the committee makes decisions based on the data, what will happen if November prices moderate sharply compared to October? We think that would complicate the outlook for the Fed, but it would not stop them from hiking. 

Smart phone prices and baby formula costs rose at record high monthly paces last month, and this will concern the Fed. The debate as we move towards the December FOMC meeting is now between a 25bp hike or a 50 bp hike. We know that Fed member Waller favours 50bp, the question now is, will others join him? 

The market reaction is as you would expect: stock index futures have dropped sharply. Nasdaq futures are now pointing to a 1% decline when markets open later, and S&P 500 futures are also down 0.5%. Bond yields have surged, US 2-year yields, which are sensitive to interest rate expectations, are higher by 12 bps so far today, which is pushing up the dollar. The USD index is higher by 0.3% today and is back above 102.00, this is weighing on the price of gold, which is lower by 1.2% so far. 

The rise in US inflation is adding to the list of woes weighing on the AI trade. Nvidia is down another 1.4% on Tuesday, Micron is down 2% and the hyperscalers like Microsoft and Meta are also lower. 

Overall, the CPI report has dampened the market mood on Tuesday. A rush to price in more rate hikes from the Fed could make it harder for the AI trade to stage a meaningful recovery.