US inflation came in hotter than expected, reinforcing concerns that the Federal Reserve is falling further behind the curve.
The US Consumer Price Index (CPI) rose 0.4% in October, exceeding expectations of 0.3%. Core inflation, excluding food and energy, increased 0.3%, also above the anticipated 0.2%.
The stronger-than-expected inflation report immediately triggered a repricing of interest-rate expectations, pushing Treasury yields sharply higher and US equity futures into negative territory.
Markets now assign an 86% probability to a 25-basis-point Fed rate hike in December, while the probability of a more aggressive 50-basis-point increase has risen to 14%.
Fed Governor Christopher Waller reinforced the hawkish message, warning that the central bank must maintain its credibility in fighting inflation and opening the door to a potentially larger rate increase by 50bps in the December meeting.
The US 10-year Treasury yield has climbed back above the critical 5% threshold, adding renewed pressure on equity valuations.
Markets:
Equities: US markets turned negative following the inflation release, while European indices remained firmly positive
Bonds: US Government bond yields moved significantly higher across the line - US 2y yield 4.77%, US 10y yield 5.00%, Japan 10y yield 2.70% - France 10y yield 4.78%
Commodities: Oil prices are flat after recent sell-off, WTI around USD 87/barrel and Brent around USD 92/barrel;
Precious metals fall with higher yields, gold at USD 4’018/oz, silver at USD 51/ozCurrencies: US dollar clearly stronger - Japanese Yen weaker USDJPY 195 - Swiss franc weakens
Cryptos: another negative day - Bitcoin below USD 72k
Volatility: The VIX index back towards 21 after falling back below 20 yesterday - The window for relatively inexpensive portfolio hedging is no longer valid
My View: Today's inflation surprise comes as no surprise to me.
I have repeatedly warned that inflationary pressures remain persistent and that the Federal Reserve is behind the curve.The latest report reinforces this assessment and raises the possibility of a more aggressive 50-basis-point rate hike in December.
Despite the recent historic technology sell-off, investors continue to underestimate the risks associated with tighter monetary policy, rising bond yields and increasingly fragile financial market conditions.
Interestingly, I increasingly hear arguments that equity valuations have become attractive following the correction, pointing to historically low price-to-earnings ratios.
But low P/E ratios do not necessarily mean stocks are cheap. Much of the apparent valuation improvement has been driven by extraordinary earnings growth concentrated in a relatively small number of companies, particularly those benefiting from the AI investment boom.
Outside this narrow group, the earnings picture looks considerably less impressive. The critical question is whether these companies can sustain their exceptional growth rates and record profitability. I have serious doubts.
Should earnings expectations begin to deteriorate while interest rates remain elevated, equity markets could face a double challenge: declining earnings estimates and contracting valuation multiples.
With the US 10-year Treasury yield back above 5%, the pressure on equity valuations is intensifying again.
In my view, financial markets have not yet adequately repriced the combination of persistent inflation, higher interest rates and increasingly uncertain earnings prospects.
The recent correction may therefore be far from over.
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