Markets to Fed: Little chance of another rate hike this year

Markets to Fed: Little chance of another rate hike this year

Federal Reserve chair Janet Yellen led a two day meeting of policymakers that ended Wednesday

The already skeptical markets now give the Federal Reserve just a 1-in-3 chance of hiking interest rates in December, after a fifth weak monthly reading of consumer inflation.

The consumer price index for July was at 0.1%, below the expected 0.2%. On the core, excluding food and gasoline, the CPI was also up 0.1%, or 1.7 year-over-year. The Fed's preferred measure, the personal consumption expenditure price data, shows an even weaker 1.5% pace.

Inflation is the missing ingredient that would put the Fed on a convincing path to raise interest rates. Even with inflation below its 2% target, the Fed has been forecasting one more rate hike this year and three next year. The markets expect just one rate hike for next year.

"It was a dud, not much doubt about that," said Michael Schumacher, director rate strategy at Wells Fargo. "It's one in a string of bad numbers. It's not a radical departure. I'm not sure it's going to sway the Fed."

More: U.S. wholesale prices edged down 0.1% in July

The central bank is expected to move ahead to begin the process of shrinking its balance sheet even before it raises interest rates again. At its September meeting, it is expected to announce that it will begin to buy fewer bonds when its holdings mature, allowing the $4.5 trillion balance sheet to wind down gradually.

"Net, net, the rising inflation trend has gone off the tracks with little price pressures reported the last five months. The cooling of inflation this late in the economic cycle calls into question just how strong the economy is," said Chris Rupkey, chief financial economist at MUFG Union Bank. "Today's report is just the sort of ammunition the Fed doves need to argue against additional rate hikes this year or even next year if they don't get confirmation that inflation is headed higher towards the Fed's 2.0% target."

Stocks moved higher after the inflation report, though markets remain under pressure due to tensions between the U.S. and North Korea. President Donald Trump kept the war of words going Friday morning when he tweeted that the U.S. is now "locked and loaded."

More: U.S. consumer prices stay soft for fifth straight month, up slight 0.1% in July

The dollar moved lower and Treasury yields, which move inversely to bond prices, also declined, with the 2-year note yield at 1.31%.

Rupkey said the bond market was rallying because the core CPI was weaker than expected, but the trend is sobering with core CPI at 0.1% for four months in a row, "a slowdown that has not been seen since late 2014/early 2015 during the oil price crash. [Fed Chair Janet] Yellen said the 0.1% drop in core CPI in March was a one-off due to your cheaper cell phone plans, but what happened to the four months since March?"

In the report, cellular phone charges, which had fallen sharply this year, continued to decline, falling 0.3% as carriers switch customers to new data plans. They are now down 13.3% over the last 12 months.

The cost of hotel and motel stays also fell a record 4.9% in July, opposite the trend in Thursday's producer price report. Medical costs were also lower, down 0.3%.

More: Postal Service calls for pricing hike as losses mount

"It's not any different than we've seen for the last several months, overall softness in price," said Tom Simons, Jefferies senior money market economist. "It's not a particularly encouraging number in it is own right. There is evidence here that we're probably at the beginning of the end of this soft period of inflation."

He said Fed funds futures show just 32% odds for a December rate hike, down from just above 40% Thursday.

Economists have said the Fed will need to see inflation pick up in the next several months, and the July reading will be dismissed. New York Fed President William Dudley said Thursday that inflation should pick up and that the Fed was still on track to raise interest rates.



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