Futures priced better than a 40% chance of a Fed increase on Oct. 28, up from about 22% before the report. Short-term Treasury yields rose more than long-term ones, the dollar touched a one-year high, and gold, silver and rate-sensitive stocks fell at the open.
Two weeks before the Federal Reserve's next decision, a single tenth of a percentage point changed what investors expect from it.
September's core consumer price index rose 0.3%, a tenth more than economists forecast, and pricing for the Oct. 27 and 28 meeting shifted within minutes. Before the 8:30 a.m. release, CME FedWatch data put the chance of a rate increase this month at about 22%. Afterward it was above 40%. Moves in bonds, currencies, metals and stocks after the release were consistent with a sooner move by the Fed.
Treasuries
The selling was heaviest at the short end. The two-year Treasury yield, the maturity most closely tied to expected Fed policy over the next couple of years, stood at 4.78% early Wednesday, according to Tradeweb, and was near 4.92% after the report, up about 13 basis points on the day. The 10-year yield rose about 9 basis points to near 5.30%, near its highest since early 2002. The 30-year yield rose about 5 basis points to around 5.61%.
Because the front of the curve rose more than the back, the gap between two-year and 10-year yields narrowed, to about 38 basis points from about 42 before the release. A narrowing driven by rising short-term yields is what bond traders call a bear flattener.
Higher Treasury yields feed into mortgage and other financing costs for households and companies.
Dollar and metals
The dollar index rose about 0.3% to 102.52 at about 9:40 a.m., after touching 102.67, the top of its range over the past year. The dollar gained about 0.3% against the yen, to 158.85.
Precious metals fell. Gold futures were down about 1.5% at $4,113.70 an ounce at the 9:30 a.m. open, and silver futures were down about 4.2% at $57.04. Brent crude was little changed near $105.90 a barrel.
Stocks
The equity reaction split by rate sensitivity. At about 9:40 a.m. the S&P 500 was down 0.3% at 7,780 and the Nasdaq Composite was down 0.5%, while the Dow Jones Industrial Average was up 0.3%. The Russell 2000 index of smaller companies fell about 1.0%.
Sector funds most exposed to borrowing costs were among the weakest. The SPDR S&P Homebuilders ETF fell about 1.3% to $93.43 after touching its lowest price in at least a year. The SPDR S&P Regional Banking ETF dropped about 1.4%, the U.S. Global Jets airline fund about 1.4% and the Utilities Select Sector SPDR about 0.5%. Long-dated Treasury funds fell as well, with the iShares 20+ Year Treasury Bond ETF down about 0.6%.
The report was not the only news of the morning. Bank of America and ASML released quarterly results before the open, and other large banks were also reporting on Wednesday, so not every move in individual sectors traces back to inflation.
The consumer
The same release that moved bonds also showed a squeeze on households. With hourly pay up 0.1% and prices up 0.6% in September, inflation-adjusted hourly earnings fell 0.5% for the month and are down 0.7% from a year earlier. Higher borrowing costs and falling real pay both bear on discretionary spending, and the Consumer Discretionary Select Sector SPDR was down about 0.6% at about 9:40 a.m.
Market implications
One reading is that the market is moving to price a Fed that acts in October. The front end led the bond selloff, the dollar reached a one-year high, and the stocks most sensitive to rates, small caps, homebuilders and regional banks, led declines.
A second reading is that the repricing is measured and reversible. Futures still give an October increase less than an even chance, the S&P 500 fell only modestly while the Dow rose, and producer prices, retail sales and a speech by Fed Chairman Kevin Warsh all arrive before the Fed goes quiet ahead of its meeting.
The figure that separates those readings is the October hike probability itself. A move above 50% after Thursday's data and Friday's speech would point to a market committing to a sooner increase. A drift back toward the low 20s would suggest the print was absorbed as one month's noise.
What to watch
September producer prices and retail sales on Thursday, Warsh's appearance at the IMF annual meetings on Friday, the two-year yield's level relative to the 10-year into the Oct. 28 decision, and the November 10 report on October consumer prices.