Inflation expectations are falling. Rate expectations are rising.

Two markets, opposite directions

The week after the November midterm elections produced a split that rarely survives contact with reality. The one-year inflation swap fell from 2.44% the day before the election to 2.16% the day after, and by November 9 it had declined to 1.94%, according to DoubleLine. Energy helped: West Texas Intermediate crude fell more than 8% in the two trading sessions following the election. On that evidence, inflation looked beaten. m:…3554

Then the October CPI report arrived and pointed the other way. Consumer prices rose 0.4% in October, above the 0.3% expected, and core inflation rose 0.3%. Goldman Sachs describes the 0.3% CPI print as the third consecutive month at that level, and calls it a number the Federal Reserve must reckon with. Two-year Treasury yields rose 17.6 basis points on November 10, according to DoubleLine, and the expected federal funds rate twelve months ahead climbed toward 4.8%. m:…3554 m:…8815

The result is a gap of about 2.6 percentage points between what markets expect inflation to be in a year and what they expect the policy rate to be. DoubleLine notes that market pricing still expects CPI fixings to fall from about 4% in January to 2.3% by May — a forecast that sits uneasily next to the rate path the same market is pricing. One of those two expectations is wrong. m:…3554

The forecasters keep adding hikes

The banks have been revising in one direction. Nomura added a March hike to its Federal Reserve forecast, now projecting increases in both December and March, driven by a hotter-than-expected October CPI report and uniformly hawkish rhetoric from Fed officials. Nomura's economists note that the share of CPI subcomponents increasing in October jumped sharply, indicating broadening inflation pressures. m:…4372

Bank of America went further, adding a hike to project three consecutive increases in December, January and March. Its strategists argue the October pause was a policy mistake, that recent 0.3% monthly inflation prints annualise to about 3.7% to 3.8%, and that the Fed is behind the curve by at least 100 basis points according to the Taylor Rule. PNC Economics, reading the producer price data, projects two more 25-basis-point hikes through early 2027. m:…3899 m:…4556

The producer price data backs the hawkish turn. Final demand producer prices rose 0.3% in October, with year-over-year inflation reaching 6.5%, according to PNC Economics. Goods producer prices rose 0.5% in the month and are 10.2% higher than a year ago, services rose 0.2% and are 5.0% higher year over year, and transportation and warehousing costs rose 2.0% in October. Energy producer prices fell 0.1% in the month but remain 36.8% higher than a year ago. m:…4556

Fifty basis points is on the table, and probably not on it

The most-discussed number in this debate is fifty. Fed Governor Christopher Waller indicated that a 0.3% core CPI reading would warrant consideration of a 50-basis-point increase, according to DoubleLine, and Goldman Sachs says Waller's comments have put 50-basis-point hikes back on the table. But Bank of America argues a 50-basis-point hike in December is unlikely, because it would make the October pause look political, and puts market pricing for that outcome at only about 10%. m:…3554 m:…8815 m:…3899

There is a self-correcting mechanism in the background that the hawks themselves acknowledge. Goldman Sachs notes that higher interest rates may create a self-balancing system by slowing the AI capital expenditure build-out, which in turn influences the Fed's policy path. Oil has already fallen about 15% in November, according to Goldman Sachs, which eases one source of price pressure even as the core numbers stay hot. The Fed goes into its December meeting with less information than usual, Bank of America notes, because the meeting was pulled forward by a week — and with two markets telling it opposite things. m:…8815 m:…3899