Week Begins with Rate Hike Odds High After CPI

Keith Lansford (0:05)

Welcome to the Schwab Market Update Podcast, where we prepare you for each trading day with a recap of recent news and a look at what's ahead.

I'm Keith Lanceford, and here is Schwab's Early Look at the Markets for Monday, September 14th. The Federal Reserve is front and center this week after Friday's August Consumer Price Index, or CPI, failed to soothe worries about surging inflation. As of late Friday, odds of a 25 basis point hike at 2 p.m. Eastern Time Wednesday were 86 percent, up from 70 percent before CPI. As a reminder, headline CPI rose 0.4 percent monthly, and core CPI, excluding food and energy, climbed 0.3 percent. Analysts had expected 0.4 percent and 0.2 percent, respectively. Annual headline CPI was 3.4 percent, in line with expectations, and unchanged from July, while core annual CPI of 2.4 percent was also as expected, and the lowest since early 2021 Despite the somewhat reassuring annual core figure, it's month-to-month core inflation that truly concerns the Fed. New York Fed President John Williams laid out the case clearly, we need to see monthly core inflation readings of 0.2 percent or less to have confidence that inflation is moving sustainably towards the Fed's 2 percent target, said Colin Martin, head of fixed income research and strategy at the Schwab Center for Financial Research. August's core CPI print came in above that. Categories where prices rose most included shelter, airfares, education, and used cars and trucks. Shelter is weighted more in CPI than in the personal consumption expenditures or PCE price index, so that might lead to some discounting of Friday's CPI. Both the CPI and last Thursday's producer price index or PPI feed into PCE, due later this month, and PCE is the Fed's favorite inflation meter. By later Friday, investors appear relatively certain that the Fed would hike this week. Failure to hike after Fed Chairman Kevin Warsh's hawkish speech at Jackson Hole last month might leave a credibility gap, now that core monthly CPI has ticked up from the more benign levels of June and July that hinted at cooling. This week is also the last Fed meeting until just before the November US midterm election. A hike in late October might be politically unpalatable, though the Fed did raise rates by 75 basis points just before the 2022 midterm vote. Those were much more inflationary times, however, and the Fed was in a heavy hiking cycle already. Treasure yields initially rose Friday after CPI, but retreated soon after. Falling crude also kept the stock market supported after the S&P 500 index posted four consecutive losing sessions. Oil retreated after the Financial Times reported that Iran and Gulf states will meet to discuss how to manage shipping through the strait. Later Friday CNBC reported that due to a tax, Saudi Arabia had shut down its key east-west crude oil pipeline. It's unclear how long this might last or the impact on exports. Despite slight pullbacks in oil and yields on Friday, they remain at uncomfortable levels for the Fed inequities. Higher borrowing costs tend to suppress economic activity and hurt future earnings growth. Crude topped $100 per barrel last week in the US for the first time since May, also raising costs for consumers and businesses. The 10-year Treasury note yield touched 4.98 percent early Friday, the highest since late 2023 It last topped 5 percent in July of 2007 It closed at around 4.97 percent Friday, perhaps setting up a test of 5 percent today. The Fed's meeting starts tomorrow and follows a rate hike late last week from the European Central Bank, designed to combat rising inflation boosted by high oil prices. The Bank of Japan delivers a rate decision this Friday and analysts also expect a hike. There's concern the Bank of Japan might get more aggressive, which could rekindle fears of the Yen carry trade breaking down and investors shifting from US to Japanese assets due to rising Japanese yields.

In other data Friday, University of Michigan preliminary consumer sentiment for September came in at 47.8, its second lowest reading on record, missing analysts' estimates of 51.5 and dropping from 51.7 in August and 55.1 a year earlier. This survey has often shown weaker results than other sentiment surveys, though the Conference Board's Consumer Confidence Index for August was also soft. Another bearish aspect of the sentiment report was long-term inflation expectations ticking up to 3.4 percent in August from 3.3 percent in July. This is a metric closely watched by the Fed.

The earnings calendar this week is arguably as light as it ever gets, with home builder Lennar among the only major companies reporting. Data resumes Wednesday with August retail sales after a light menu today and tomorrow. Friday is traditionally known as Triple Witching Day when options expire for various traded products. This could fuel volatility later this week as funds shift positions. Last Friday, major indexes rebounded from four days of losses despite the warm CPI report and rising rate hike odds, possibly because CPI removed any final ambiguity around Fed policy. Markets tend to flinch from uncertainty. Initially, stocks got help from falling oil. Tech strength also contributed amid bullish reports from the options market and possibly some buy-the-dip action. The Russell 2000 small cap index, more exposed to high borrowing costs, trailed others. The broader market ended the week down a bit less than 1%.