It's a new month, and the Federal Reserve's second-to-last meeting of the year is on tap to take place this week. Many investors expect another jumbo-size rate hike this time around, which has become the norm for just about every Federal Reserve Board meeting since June.
But over the last several weeks, the market seems to have shifted its expectations regarding inflation and what it thinks is the Fed's trajectory. It wasn't too long ago when a small percentage of market participants thought the Fed might have to do a full 1 percentage-point rate hike at one of its meetings this year to get the highest inflation rate in 40 years back under control.
Now, there is increasing chatter that there could soon be a Fed pivot to smaller rate hikes and that inflation may be starting to ease faster than expected. Which prognosticators have it right? Let's take a look.
Shifting expectations about inflation
Earlier this month, the Consumer Price Index (CPI), which tracks the prices on a select basket of consumer goods and services over time, showed that prices in September had actually ticked up from August. It was considered a very sobering inflation report. The CPI rose 0.4% from August, its largest monthly jump in three months. Meanwhile, the core inflation rate, which doesn't factor in food and energy prices, rose 0.6% from the prior month.
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That CPI report had a small group of speculators advocating for the Fed to raise its benchmark overnight lending rate, the federal funds rate, by a full percentage point. Several weeks later, however, that speculation appears to no longer be in consideration, according to the CME Group's FedWatch Tool, which looks at 30-day futures options betting on how the Federal Funds Rate will move.
As of Oct. 31, about 86% of investors speculating through the FedWatch Tool were betting on the Fed to jack up its federal funds rate by 0.75 percentage points at its November meeting, which would be the fourth consecutive hike of that rate this year. This would bring the federal funds rate to within a range of 3.75% to 4%. However, 14% of investors active in this futures market believe the Fed will only enact a half-point rate hike.
Such a move would certainly be an interesting turn of events and likely represent a pivot from the Fed's current hawkish policy. It would also likely mean the bulk of the Fed's rate hikes is done. If true, such a change could drive stocks higher.
There's been some encouraging macroeconomic data recently that suggests prices could be starting to level off in some parts of the economy. For instance, last week, the U.S. Department of Labor showed through its Employment Cost Index that wages in the private sector increased 1.2% in the third quarter of the year, down from a 1.6% rise in the second quarter.
How the Fed could show a pivot tomorrow?
Obviously, the easiest way for the Fed to pivot on Wednesday would be to only do a half-point rate hike. But along with the great majority of the futures market, I find this course of action unlikely.
The market continues to be worried about where the economy is headed in 2023, and the Fed will likely want to stay on the offensive while the economy and labor market are still in a relatively strong place.
But the Fed could make comments along with the release of its rate hike plan suggesting that the data on inflation is encouraging. This could send a possible signal to investors that it would only do a hike of a regular quarter-point percentage point at its December meeting instead of the expected half-point hike. If the market sees that Fed members believe inflation is actually peaking, I think that would lead many traders to believe the Fed is pivoting, which could move stocks higher.
The Fed concludes its meeting around 2 p.m. ET Wednesday when it will likely announce a rate hike of some kind and offer up some commentary on the decision as Fed Chairman Jerome Powell speaks to the press about the announcement. Be prepared for some market response no matter what ends up being said.
