Why rates keep rising: hot CPI, and an AI return hurdle above the Fed funds rate

The hot print

The latest CPI print gave the hawks their ammunition. September's core CPI rose 0.33%, well above the 0.22% consensus, in what J.P. Morgan called the largest upside surprise for inflation markets since March 2024. The increase was broad-based, super core services up 0.42% and core goods running at a 2.2% three-month annualized rate, unlike August, which was dominated by wireless telephone services. Origin Financial's Austin Payne puts the September headline at 3.7% year-on-year on a 0.6% monthly rise, driven by a 9.1% monthly surge in gasoline prices, with real hourly earnings down 0.5% in the month and 0.7% over the past year. The squeeze on households is real: consumer sentiment fell to 46.3 in the preliminary October survey, and markets priced in almost a 40% chance of a Fed hike after the report. m:…3866 m:…0438

The December question

Standard Chartered's Jonathan Liang reports headline CPI at 0.6% month-on-month and 3.7% year-on-year, with core at 0.3% and 2.6%, and blames energy spillover: rising diesel prices bleeding into the broader economy. His call is that the Fed holds in October and hikes in December, and possibly hikes twice more by June 2027. J.P. Morgan also maintains a December hike forecast, while noting Fed speakers have pushed back on the idea of a hike at every meeting and that uncertainty lingers over Kevin Warsh's potential influence on the committee. Liang puts the 10-year Treasury within a 5% to 5.25% forecast range and notes that high-quality bond portfolios can now yield 6% or more. m:…2385 m:…3866

J.P. Morgan's inflation-market detail is worth the look. The firm estimates core PCE inflation rising from 3.0% to 3.1% year over year, expects the five-year point for TIPS and breakevens to see carry of around 10 basis points, and has shifted its inflation-market stance to neutral with upside risks. Core goods inflation is showing persistence at a 2.2% three-month annualized rate, technology price increases announced in October are adding short-term pressure, and rising diesel-driven transportation costs are lifting supply-chain costs. m:…3866

The AI hurdle

Apollo's Torsten Slok offers the structural reason this keeps happening: expected AI returns exceed the Fed funds rate. With investors expecting AI investments to return more than 10% against a 4% funds rate, the AI spending boom is not sensitive to interest rates, because borrowing costs sit far below expected returns. Upward pressure on rates, Apollo argues, persists until the Fed raises rates above expected AI returns or expected AI returns fall below the funds rate. This suggests the rate floor is set by technology expectations, not by monetary policy alone. m:…5593

The evidence fits the thesis. Ten-year yields have risen 125 basis points over the past year even as consensus forecasts for 2027 capital expenditure growth were revised upward. Fiscal challenges and heavy Treasury issuance are adding to the term premium, reinforcing the upward trajectory. In Apollo's telling, tighter monetary policy is losing its effectiveness on the economy, the bottom line being that higher for longer continues in both public and private markets. What Apollo leaves open is the threshold: at what point AI return expectations might decline below the funds rate and release the pressure. m:…5593