Market Insider

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

Key Points
  • The CPI for July was 0.1 percent, weaker than economists expected and the fifth miss in a row.
  • The market immediately lowered the odds of a rate hike for December in the Fed funds futures market to about a 1 in 3 chance.
  • Stocks had been heading lower but reversed themselves after the report.
Janet Yellen, chair of the U.S. Federal Reserve, listens during a House Financial Services Committee hearing in Washington.
Zach Gibson | Bloomberg | Getty Images

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

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

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 percent 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."

The dollar moved lower and Treasury yields, which move inversely to bond prices, also declined, with the yield at 1.31 percent.

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 percent 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 percent 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 percent as carriers switch customers to new data plans. They are now down 13.3 percent over the last 12 months.

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

"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 percent odds for a December rate hike, down from just above 40 percent 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.