The Kobeissi Letter
@KobeissiLetter
The Fed's worst nightmare just got worse: ALL 3 major metrics of inflation in the US are rising and rate HIKES recently became more likely. Meanwhile, President Trump just said that he will "DEMAND that interest rates drop immediately." What will the Fed do now? (a thread)
It is clear that inflation is HOT, even with the unexpected drop in Core CPI, to 3.2%. 1-month annualized core PCE inflation is at 3.5%+ and and core CPI is 120 basis points above the Fed's target. 1-month, 3-month, and 6-month annualized core PCE inflation are rising.
When the Fed "pivoted" in Sept 2024, they noted that the labor market was weakening. They felt inflation was falling to 2% and the labor market needed support. Instead, inflation is now rising and the December jobs report CRUSHED expectations. Unemployment is down to 4.1%.
Meanwhile, ISM Services Price Paid data is coming in HOT. This is considered a leading indicator for PCE inflation, the Fed's preferred inflation metric. We now have PCE rising again as Prices Paid rebound, this should also put PCE above 3.0%. 2% inflation is distant now.
The Fed still felt like they had everything under control, they just needed to PAUSE rate cuts. Bond markets were already trading as if rate hikes returned, helping righten financial conditions. This led yields on 10 year rates to their highest against 2 year rates since 2022.
Also, the equity market remained fairly unfazed even with the rapid spike in yields. Even as the 10-year note yield neared 5%, the S&P 500 and Nasdaq kept pushing higher. The Fed could become LESS dovish without worrying about markets as much. This gave the Fed some relief.
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However, the Fed is now dealing with another major hurdle. President Trump is calling on the Fed to cut rates even as inflation rebounds. His plan is that lower oil prices will help offset the effects of lower interest rates on inflation. Will this idea actually work?
Since inauguration, oil prices have traded lower on his promises of higher production. Offsetting the effects of lower rates would require VASTLY lower prices, if even possible. Let us know if you'd like a thread on this concept. Oil prices will be highly volatile in 2025.
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Since rate cuts began in September 2024, the 10-year note yield is up ~110 basis points. In almost all instances, other than 1998, interest rates FALL when the Fed cuts rates. Yields dropped slightly after Trump's statement today, but they remain strong. What will the Fed do?
We now have the Fed vs market vs Trump. Rate expectations have shifted HIGHER, from the blue to white line. Markets see less rate cuts, the Fed will pause, and Trump wants lower rates. Who will win? Follow us @KobeissiLetter for real time analysis as this develops.
