Traders Expecting Inflation to Approach 2% by Next Year
Traders are closely watching the Federal Reserve's efforts to achieve a 2% inflation target in the coming year. Both core and headline readings from the consumer-price index are being analyzed to gauge the progress.
According to traders, fixings—a type of derivative instrument—indicate that core CPI will likely reach an annualized rate of 2.6% in the first 10 months of 2024. The fixings market has shown a higher level of accuracy when predicting inflation trends, especially during the recent surge in price gains from 2021-2022.
Additionally, fixings traders anticipate that annual headline inflation will return to the Fed's 2% target by October next year. This prediction takes into account a neutral outlook for energy prices due to their uncertain trajectory.
Although policymakers primarily rely on the personal consumption expenditures price index to determine their inflation target, they consider other indicators as well. Headline CPI is taken into consideration because of its impact on household expectations, while core rates are seen as a more reliable reflection of underlying trends.
Currently, fed funds futures traders are pricing in a 73.6% probability of three to five quarter-point rate cuts by December 2024. The next round of interest-rate projections by Fed officials is scheduled for release on Wednesday, although no immediate action is expected, and borrowing costs are projected to be maintained between 5.25%-5.5%.
The Fed's Rate Cut Strategy and Inflation Expectations
The market has been anticipating the Federal Reserve's gradual rate cuts, viewing it as a risk-management measure similar to the preemptive rate cuts in 2019. These cuts were aimed at preventing a recession in the United States. Gang Hu, an inflation trader at New York hedge fund WinShore Capital Partners, suggests that given the number of anticipated rate cuts and uncertainty surrounding future inflation trends, Fed officials may not rush to cut rates immediately.
Hu believes that their primary concern now is to firmly control inflation expectations and avoid a wage inflation spiral. Therefore, he thinks it is more likely that the Fed will push back on rate-cut expectations and be behind the curve. The upcoming Consumer Price Index (CPI) data for November is expected to show a monthly rise of 0.3% in core inflation, compared to the 0.2% gain seen in October. This will likely keep the annual core rate at an elevated 4%. However, falling gas prices in November have been gradually pushing headline inflation lower.
In related news, falling gas prices are expected to bring relief to consumer inflation once again in November. Additionally, gas prices may even fall below $3 per gallon, which could be a pleasant surprise for holiday travelers.
As of Monday afternoon, Treasury yields were relatively stable, with a slight upward movement observed as the market absorbed two government auctions. Meanwhile, U.S. stocks, including DJIA, SPX, and COMP, were mostly on the rise.
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