We get the big October inflation report tomorrow.
As we’ve discussed over the past week, if inflation continues to go the Fed’s way (i.e. continues to trend lower), the Fed will have to cut rates aggressively next year, otherwise real interest rates (the difference between the Fed Funds rate and inflation) will continue to rise, which will tighten financial conditions even further.
They haven’t acknowledged it. But it’s obvious. In fact, UBS said today that they expect the Fed to cut by 275 basis points next year!
So, what does tomorrow’s inflation number look like?
The consensus view is for a 3.3% year-over-year change.
Remember, a powerful driver of falling inflation (the fall from over 9% to 3%) has been DEFLATION in energy prices. That said, that deflationary contribution from energy prices should be waning, given supply/demand fundamentals. But October was a reprieve.
If we look at the price records from the EIA (Energy Information Administration), the year-over-year change across broad energy should be negative for the month of October.
That should contribute to a slide in October headline inflation from 3.7% (the prior reading). And that should be welcomed by markets and cheered by the media — more fuel for stocks, and more downward pressure on bond yields.
And this will come as we already have this bullish trend break across the S&P 500, Nasdaq and DJIA …
And 10-year yields are already trading in the mid-4% area, after failing to break above 5%.
With that, the Fed has a line-up of speakers this week. We should expect them to curb any enthusiasm. Remember, they’ve acknowledged that higher longer-term bond yields, lower equity prices, and a strong dollar have “tightened financial conditions significantly.”
But they’ve also made it clear that they want these conditions to persist.