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Market Extra: Financial markets cling to hope that inflation is easing ahead of October’s CPI data

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With the next major U.S. inflation report about to land on Thursday, traders and investors continued to cling to hopes that the data will contain enough signs of easing price pressures to help move the needle on the Federal Reserve’s December rate hike.

Economists and traders are expecting Thursday’s consumer-price index report for October to produce the first annual headline reading below 8% of the past eight months. In addition, fed-funds futures reflected a 57% chance on Wednesday that policy makers will back off their series of jumbo rate increases of 75 basis points and hike by a smaller increment of half a percentage point next month, even though there’s still one more inflation report to consider after the October reading arrives.

There’s no shortage of material for financial markets to parse in Thursday’s CPI report. On one hand, October’s CPI is likely to include another sharp monthly reading, of 0.6% versus 0.4% in September, based on the forecasts of economists polled by The Wall Street Journal. On the other hand, the monthly core reading, which strips out food and energy to provide a less volatile read on inflation, is seen as dropping to 0.5% from 0.6% previously. The attention-grabbing annual headline rate, which can impact households’ expectations, is also seen as sliding to 7.9% in October from 8.2% in September.

“We are hoping for the best, but preparing for the worst because the data has continued to surprise,” said Brian Jacobsen, a senior investment strategist at Charlotte, North Carolina-based Allspring Global Investments, which manages $463 billion. “We are expecting durable-goods prices to stabilize, if not fall, but have no idea what to expect from the services numbers. There’s such a wide range of possible outcomes that I don’t have a lot of confidence in the forecasts.”

Ahead of Thursday’s CPI report, Allspring is heading into consumer-staples and energy stocks rather than the broader S&P 500 index
SPX,
-1.67%
,
and has been overweight U.S. equities relative to those of Europe, while considering taking positions in real-estate investment trusts, Jacobsen said via phone.

Meanwhile, traders of derivatives-like instruments known as fixings expect the annual headline CPI rate for October to come in at 7.9%, matching the median forecast of economists. From there, fixings traders, who have focused mostly on inflation’s potential for upside surprises during the past year, now see the annual headline rate slipping to almost 7.4% and 7.1%, respectively, for November and December, before dropping further to around 3% by July.

“Everyone is, again, looking for a pivot in CPI,”said Gang Hu, a TIPS trader with New York hedge fund WinShore Capital Partners. “The market is looking for a reversal, this time with good reason, and is expecting the housing and medical components of the report to turn. The market is also looking ahead to see whether or not the economy will slow down at some point, regardless of the CPI number, which would fix the inflation problem.”

Unless Thursday’s CPI contains a major upside or downside surprise that causes stocks and bonds to either sell off or rally in tandem, financial markets could be heading into a relatively quieter period compared with earlier this year because of the Fed’s post-meeting guidance last week, which gave investors more clarity about the likely path of interest rates, Hu said. He said that if October’s inflation data is in line with expectations, stocks are more likely to be influenced going forward by weaker-than-expected corporate earnings or any possible spillover from recent crypto turmoil.

Thursday’s data is also unlikely to make much difference to the market’s current thinking about how high the Fed will end up lifting the fed-funds rate target in the first half of next year, which is mostly seen as between 5% and 5.25%, according to the WinShore Capital trader. That should leave 10- and 30-year Treasury yields trading within recent ranges, he said.

All three major U.S. stock indexes
DJIA,
-1.59%

SPX,
-1.67%

traded lower Wednesday afternoon, led by a 2% drop in the Nasdaq Composite, after three straight days of gains. Treasury yields were mixed, with the 10-year rate
TMUBMUSD10Y,
4.152%

hovering around 4.15%.

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