Hot CPI has traders pricing in a supersized Fed hike in December

The consumer price index rose 0.4 percent in October, more than the 0.3 percent Dow Jones consensus estimate, and traders are now pricing in a chance of a supersized half-point interest rate increase in December, CNBC reported.

The numbers, coupled with earlier comments from Federal Reserve Governor Christopher Waller, have some traders suddenly assigning real probability to a 50-basis-point hike. The CME Group’s FedWatch tool shows an 11 percent chance of a half-point move in December, up from zero a week ago, according to CME data. Expectations for a quarter-point increase stand at 88 percent, up from 77 percent a week ago. A week ago, the market was debating whether the Fed would hike at all. Now it is debating how much.

Wall Street had recently been able to put inflation worries on the back burner, as traders focused on the midterm elections and wild swings in tech stocks. That is over. The CPI report brought inflation back to the front of the market’s mind, and the reaction was immediate. Equities took a hit following the release. The benchmark 10-year Treasury note dropped, pushing up its yield nearly 10 basis points to 4.95 percent, approaching the 5 percent level that spooks stock investors.

Christopher Rupkey, chief economist at FWDBonds, did not mince words. “The consumer’s inflation nightmare continues on at the start of the fourth quarter with no relief in sight where this month’s grocery bills have jumped and the cost of dining out is sky-high,” Rupkey said. “Inflation is not rolling over and playing dead and fed officials are going to need to bring a bigger hose if they have any hope of putting the inflation fire out.” His recommendation was blunt: “Sell stocks, sell bonds, sell it all.”

Lindsay Rosner, head of multi-sector fixed income investing at Goldman Sachs Asset Management, said the hot CPI signals Fed hikes could spill into 2027. “The Fed could push for a more-aggressive tightening cycle with CPI continuing to print strong. A December hike is our firm base case despite wider AI jitters, and stubborn inflation means we cannot rule out further hikes in 2027,” Rosner said.

Ian Lyngen, head of U.S. rates at BMO, said the combination of strong October payrolls and sticky core-CPI suggests that not only is a December hike a foregone conclusion, but also that a 50-basis-point hike will be discussed in the context of ensuring Fed credibility. “From here, the market will continue to cheapen up the front-end of the curve as a nonzero probability of a 50 bp move is priced in,” Lyngen said.

Not everyone thinks the Fed goes big. Chris Zaccarelli, chief investment officer for Northlight Asset Management, said he expects the Fed to raise rates by 0.25 percent next month, not 0.50 percent. “Given the higher-than-desired inflation, it is even more likely now that the Fed will raise rates in December and although some are calling for a 0.5 percent increase in the Fed Funds target rate, we expect that they will only raise rates by 0.25 percent next month,” Zaccarelli said.

Bret Kenwell, U.S. investment analyst at eToro, identified the real risk as a higher rate path rather than a single hike. “Markets have handled elevated Treasury yields and a stronger U.S. dollar better than many investors expected. But that resilience could be tested if markets begin pricing in multiple rate hikes and yields move higher in response. The bigger risk is not simply higher yields, but a higher rate path,” Kenwell said.

What I think

The shift from “will they hike?” to “how much will they hike?” happened in a single CPI report. A week ago, the market was debating whether the Fed would move at all in December. Now the debate is between 25 and 50 basis points, and the 10-year yield is back near 5 percent. That is a massive change in market expectations driven by one inflation print, and it tells you how fragile the soft-landing narrative was. The market wanted to believe inflation was dead. It is not.

Waller opened the door to a half-point hike, and the market immediately walked through it. An 11 percent probability is not high, but it was zero a week ago. The FedWatch tool will adjust as new data comes in, and if November’s CPI is also hot, that 11 percent becomes 30 percent or 40 percent. The Fed does not want to surprise the market, so if they are leaning toward 50, they will use speeches and interviews to prepare the ground. Waller’s comments were the first step in that preparation.

Rupkey’s “sell everything” is the kind of call that sounds dramatic in the moment and is usually wrong in hindsight. The economy added 165,000 jobs in October, the labor market is strong, and a rate hike is not going to cause a recession next quarter. But the direction of his argument is right: inflation is not cooperating with the Fed’s plan, and the Fed is going to have to be more aggressive than the market expected. That means lower stock prices, higher bond yields, and a stronger dollar. The question is how much lower and how much higher.

The 10-year yield at 4.95 percent is the number to watch. If it crosses 5 percent and stays there, the valuation math for every asset class changes. Stocks trade at lower multiples, housing becomes less affordable, and the cost of capital for companies like CoreWeave goes up. The Fed’s rate hike is not just about inflation. It is about the price of everything, and the market is only beginning to reprice.