CPI Reaction and the Rate Hike
CPI came in mostly in line with street expectations, both core and headline. The market read this as not removing upside inflation risk. CME Fed funds futures now price in a rate hike next week as close to a done deal. The Fed rarely goes against what Fed funds futures price in, especially 5 days out from the meeting.
This price certainty - a clear path for where rates go - is the main reason for the market rally. Two other factors help: a decent pullback earlier in the week, and seasonality. September 11th is one of the more bullish days of the year.
A 25 basis point hike would be symbolic. It will not affect energy supply or consumer demand, but it shows the Fed trying to act responsibly on inflation. Looking ahead to March next year, the year-over-year comparisons start to look favorable for the Fed even if diesel and gasoline stay at current levels. So rate hikes now may not last long, and the market is likely pricing that in too.
The Yield Curve
The 2-year yield is picking up at 458. The 10s and 30s are coming off a bit. That was the expected reaction: if the Fed hikes next week, the long end backs off, which had been an area of concern. Bessent made supportive comments to Bloomberg terminal users the prior day.
Diesel, Gasoline, and Crude
Diesel hit $6 a gallon for the first time ever - AAA showed it at 430, a 24% jump in August. Diesel is trading at all-time highs. It is a big input cost, especially for farming, though most consumers do not buy diesel at the pump, so gasoline is where sentiment comes from.
Crude oil is pulling back. There are unconfirmed reports the East-West pipeline was struck and damaged the prior evening - neither Saudi Arabia nor Saudi Aramco has confirmed it. If the East-West pipeline was hit, it could disrupt another 7 million barrels of flows per day and push prices higher. Rumors that some GCC countries may meet with Iranian foreign ministers next week are also cooling the oil market.
Crude has been trading in a band between $93 and $105. That zone is where a lot of jawboning starts within the market, usually from the administration, with announcements aimed at calming tensions. It remains a risk area for bulls, though prices are trying to curl higher.
Over the next two weeks, diesel demand should rise as refiners begin their maintenance season and switch to winter blend for regular gasoline, which tightens utilization rates. EIA data from the prior day showed US gasoline demand only slightly above 2020 COVID-19 levels - a sign higher prices are cutting into consumer demand. Some Fed members are likely watching that data.
The setup is close enough to the midterms that there is a push to draw the oil market lower. Saudi Arabia, seeing much of its infrastructure hit, may also want to calm tensions to protect that infrastructure. Similar affordability and midterm calculations may be driving copper prices, which made an interesting move tied to positioning around tariff news.
Consumer Sentiment
University of Michigan consumer sentiment came in at 47.8, in contractionary territory (51 marks expansionary). That is down from 51.7 last month. Current conditions came in at 50.9 versus 51.3 expected. Consumer expectations were 45.8. This could be one of the lowest prints since the data set began, lower even than during COVID-19; expectations were 50.5. One-year inflation expectations ticked up to 4.6% from 4% last month.
The consumer clearly does not feel good with the resurgence in fuel prices. For the Fed, this cuts two ways: a weaker consumer may pull back on spending, which could tame core or services inflation. Wage growth is decelerating, so wages will not pressure inflation for now. Most current inflation is still in goods. It would take another three to four months of high energy prices to feed into the services side. If gasoline stays tame, sentiment may bottom out around these levels. A bit of demand destruction could give the Fed reason to stop hiking.
