As the U.S. Federal Reserve’s messaging gets blurrier, markets are focusing on the data.

Birds of prey have benefitted from legal protection in North America for more than a century. Nonetheless, the bond markets have persisted in taking shots at the kettle of hawks that comprises the current Board of the U.S. Federal Reserve.

When U.S. Consumer Price Index data released on October 13 came in much worse than consensus expectations, rates moved to new cycle highs. Markets were retracing some of that move when, at the November 2 Fed meeting, Chair Jerome Powell gave a press conference that was clearly more hawkish than the accompanying press release. Market rates promptly went back to their recent highs and beyond.

Days later, CPI data released on November 10 was much better than expected. That set off a U.S. Treasury market rally of 35 to 56 basis points across the yield curve—only to be followed by the kettle of hawks screeching to remind everyone of their resolve.

What to make of all this? Are markets “fighting the Fed”—or just ignoring it?


Much of the November 10 inflation data was encouraging.

Energy inflation popped back up, and could remain volatile due to uncertainty around geopolitical flashpoints and China’s COVID policies, but food inflation has begun to show signs of deceleration. We see that normalizing rapidly by the first half of next year. Core goods actually slipped into deflation as used car prices declined and supply chains cleared.

The dynamic in services, which can generate more persistent, stickier inflation, was less clear. Shelter cooled from its peak on weakness in the housing and rental markets, and while we expect that cooling to continue, we think the rate of deceleration in house prices will be slower and shallower than the fall. Inflation in core services excluding shelter also moderated, but this was largely due to technical issues with medical care services, where we expect prices to rebound over the coming months.

Despite encouraging signs that “trimmed-mean” inflation indices are topping out, suggesting that the broadening of price increases might be peaking, it’s notable that the prices of many items that typically exhibit “high-persistence” inflation remain high and are rising. That appears to be reflected in a recent uptick in surveys of consumers’ long-run inflation expectations, and in last Wednesday’s strong U.S. retail sales data.


Nonetheless, the market appears to be focused on direction rather than degree. With peak inflation behind us, investors seem confident that central banks will ease off on the hawkishness.

This isn’t just about equity markets rallying. They did that in June and July this year, before it was confirmed that U.S. inflation had peaked at 9.1%. This time, the turn in sentiment appears to be different.

For example, since the inflation data release on November 10, the FANG+ Index of long-duration technology stocks has risen almost as much as it did over the entire two months of the summer rally. Cyclical stocks have generally risen much more sharply than defensives since November 10. Gold enjoyed a 7% rally over one month in the summer, but has already soared by 10% in the two weeks since Powell’s hawkish press conference. The U.S. dollar kept on strengthening during June, July and August; it has weakened substantially so far in November.


Where does the Fed fit into this?

We think the market confusion around the November 2 meeting might have been a turning point. Powell used his press conference to insist that dovish new language in the official statement applied only to the pace of rate hikes—not the level of the eventual terminal rate or the length of time it would need to be maintained.

Some commentators have called this subtle, others unclear. We err toward the latter and think the market does, too.

Investors appear to have started shutting out the screechy, hawkish messaging to refocus on the hard economic data. We think that’s why they greeted the November 10 inflation release so positively despite policymakers insisting they would need to see lower numbers before making any kind of pivot. Markets are pricing for a lower terminal rate than that suggested by the Fed’s dot plot or policymakers’ commentary, apparently because slower rate hikes will mean more time for the economy to cool off before the central bank gets to those levels.


Nonetheless, the Fed hawks are unlikely to be scattered by one set of numbers. Where things stand by midyear will be especially important, in our view, given the Fed’s indication of the likely policy trajectory.

We currently anticipate 4% for headline CPI and 4.5% for core CPI in June 2023. Even by the end of next year, we think headline inflation will still have been squeezed down only to 3.6%, and we continue to see secular forces causing a bias to higher inflation for the long term. If that outlook is close to being correct, we think the Fed’s resolve today is appropriate.

What does all that mean for our view on rates? On the one hand, it suggests that the month-to-month drama around CPI releases is likely to continue into 2023. On the other, we have likely seen the peak in inflation, and we think that means the time for extreme caution has passed. Since our latest Fixed Income Investment Outlook, therefore, we have moved from neutral to more constructive in our view on duration, poised to take advantage of opportunities as they arise.

In Case You Missed It

  • Japan 3Q GDP (Preliminary): -0.30% quarter-over-quarter in Q3 (seasonally adjusted)
  • U.S. Producer Price Index: +8.0% year-over-year and +0.20% month-over-month in October
  • Eurozone 3Q GDP (Second Preliminary): 0.2% quarter-over-quarter in Q3
  • NAHB Housing Market Index: -5.0 to 33.0 in November
  • U.S. Retail Sales: +1.3% month-over-month in October
  • U.S. Housing Starts and Building Permits: Housing Starts fell 4.2% month-over-month and Building Permits fell 38K to 1,526K in October
  • Japan Consumer Price Index: National CPI rose +3.7% year-over-year and Core CPI rose +2.5% year-over-year in October
  • U.S. Existing Home Sales: -280K to 4,430K in October

What to Watch For

  • Tuesday, November 22:
    • Eurozone Consumer Confidence Indicator (Flash)
  • Wednesday, November 23:
    • Eurozone Markit Purchasing Managers’ Index (Preliminary)
    • U.S. Markit Purchasing Managers’ Index (Preliminary)
    • University of Michigan Sentiment (Final)
    • U.S. New Home Sales
    • November FOMC Minutes
    • Japan Markit/JMMA Purchasing Managers’ Index – Manufacturing (Preliminary)

    Investment Strategy Group