Hot inflation report means markets face a more aggressive Fed and likely recession

Published Thu, Oct 13 202210:28 AM EDTUpdated Thu, Oct 13 202211:06 AM EDT

Patti Domm @in/patti-domm-9224884/@pattidomm

Another hotter-than-expected inflation report puts pressure on the Federal Reserve to raise interest rates even more aggressively, but that also could tip the economy into a recession. Stocks declined and Treasury yields rose, after September's consumer price index showed inflation running at a 0.4% pace. The 10-year Treasury yield rose above 4% but was at 3.98% in mid-morning trade. Yields move opposite price. In the futures market, traders bet the Fed would drive its fed funds to near 5% by next April, up from 4.65% on Wednesday. "This is the Fed hitting the brakes hard now," said Diane Swonk, chief economist at KPMG. "Now the Fed is really taking the punch bowl away. The question is how many people are stumbling around hung over? What we don't know is when you turn on the lights after the party, what you're going to find." Swonk said she had expected the Federal Reserve to end its rate hikes when it reached 4.5% next year, but she, like the futures market, now expects the terminal rate could be more like 5%. She also notes that September was the first month where the Fed managed the full $95 billion-a-month rundown of its balance sheet, adding more tightening pressure to the economy. The terminal rate is the end rate where the Fed would stop its hiking for this cycle. "The Fed's job is not done," said Liz Ann Sonders, chief investment strategist at Charles Schwab. "It cements 75 in November, probably keeps December in the 50 to 75 basis point range, and markets don't like it." (One basis point equals 0.01%.) She said stocks have more of an adjustment to make, as some investors still believe the Fed could move to cut rates later next year, once it ends its hiking regime. "I still think the market, as an entity, has not quite come to grips with what the Fed is trying to drive home, which is not so much the length of time they're going to hike," Sonders said. Fed officials have been emphasizing that once they finish raising rates, they intend to hold them there to continue the fight against inflation. For markets, that could mean a bigger downward adjustment in stock prices. The September CPI was particularly troubling, since it follows a hotter-than-anticipated August report. Economists had hoped to see inflation cool, and signs it was peaking for good. "The reality is what we saw today was August was not a glitch. It was not a fluke. It was more of a trend of more entrenched inflation, especially in the service sector, and that's what I think is so difficult about this," said Swonk. "It's much harder to fight." Consumer prices were up 8.2% on annual basis in September, after rising an also higher-than-expected 8.3% in August. Excluding food and energy, the core consumer price index accelerated 0.6% and 6.6%, respectively. The yearly gain for core was the highest since August 1982. "The higher rates go, the more difficult it's going to be. Mortgage rates just got over 7%. The higher cost of capital is further going to slow things down," said Peter Boockvar, chief investment officer at Bleakley Advisory Group. Recession warnings have been increasing, including a high-profile warning this week from JPMorgan Chase CEO Jamie Dimon, who said he expects the economy to tip into a recession in the next six to nine months. "The Fed's just going to accelerate the recession. The reality is they've got to be all in. They don't have a choice," said Swonk. "You can't get out of it until you know inflation is tamed." She expects the economy to dip into a recession starting later this year.