US inflation ticks up to 2.6% – What’s the Federal Reserve to do now?

Inflation in the United States just hit 2.6% in October, giving the Federal Reserve plenty to chew on before its next – and final – meeting of the year.

With President-elect Donald Trump about to take back the Oval Office, the Fed faces a critical choice: Should it go ahead with another rate cut? Or will rising prices force the central bank to hold steady?

Wednesday’s report from the Bureau of Labor Statistics met economists’ predictions, but it still raises tough questions. Food and energy aside, core inflation stuck at 3.3% over the past year. Monthly core prices, though, climbed 0.3% for the third month in a row. So, let’s get this straight – inflation is far from tamed.

The Fed’s benchmark rate already sits between 4.5% and 4.75% after two cuts totaling 0.75 percentage points across recent sessions. The goal here? A “neutral” rate that controls inflation without killing demand, ideally delivering a so-called soft landing that avoids the R-word – recession.

Wall Street still expects a December rate cut

Wall Street’s reaction to the inflation bump? An all-in bet on a rate cut in December. The futures markets are pricing in about an 80% chance that the Fed will slash rates by a quarter point at its next meeting, up from 60% before this latest inflation report.

Treasury yields, especially the two-year notes that track rate expectations, fell by 0.08 percentage points to 4.26%. Investors are clearly banking on the Fed coming through with more cuts.

On the stock side, the market didn’t go wild, but it didn’t tank either. The S&P 500 and Nasdaq both crept up 0.1% at the opening bell. Sarah House, a senior economist at Wells Fargo, said, “We’re seeing some relief that [the inflation data] wasn’t an upside surprise.”

Meanwhile, consumer spending shows no signs of slowing down, with recent retail sales data indicating that Americans are still buying. Despite a rocky October jobs report – affected by a Boeing strike and hurricane-related disruptions – overall, the economy isn’t falling apart.

This past month alone, prices nudged up again by 0.3%, following a pattern seen over recent months. Housing-related costs accounted for about half of this increase, and airline fares also crept up, while clothing and furniture prices dropped slightly. Energy prices didn’t budge after sliding 1.9% in September.

Fed Chair Jay Powell has already warned of a “bumpy path” toward inflation goals, expecting prices to gradually settle closer to the Fed’s 2% target. And while Minneapolis Fed President Neel Kashkari acknowledged inflation is “headed [in] the right direction,” he also added a dose of caution.

Trump’s election and market moves

Donald Trump’s election win has thrown a whole new layer of unpredictability into the mix. With the president-elect planning to unleash a raft of new policies – think tariffs, tax cuts, and stricter immigration rules – the Fed’s inflation battle could face fresh complications.

Economists are worried that these changes might fuel price hikes. Before the inflation data hit, investors were bracing for higher Treasury yields under Trump, with some predicting significant Treasury losses. But this CPI report shifted those expectations, doubling down on the probability of a December rate cut. 

Treasury futures saw a jump in activity, especially in five-year notes, as traders scrambled to lock in bets on a Fed rate cut.

“Bang in-line core inflation leaves the Fed on track to cut rates in December,” said Lindsay Rosner, an economist from Goldman Sachs Asset Management. She thinks the CPI helped ease fears of a sudden slowdown in rate cuts after a run of hotter-than-expected autumn data.

But Barclays economist Pooja Sriram suggested it could “still be a close call,” as the Fed awaits another payroll and CPI report before the next Federal Open Market Committee (FOMC) meeting on December 18.

While Treasury yields on long-term notes initially dipped, they quickly rebounded as new corporate bonds surged into the market. Trump’s anticipated tax policies could fuel inflation further, and his win has left Republicans in control of Congress, giving his economic plans a clear path forward.

Economist Frances Newton Stacy said, “The biggest news we are interested in is the fiscal adjustment and what that is going to look like” under Trump. “Bonds are having a hard time pricing all this in,” she added.

Fed officials stay cautious amid rising inflation

For the Fed, the entire future of rate policy hangs in the balance. Powell and the other Fed officials have said clearly that inflation, not political events, will dictate their decisions. “In the near term, the election will have no effects on our policy decisions,” Powell said last week.

Other officials sounded off as well, each one eyeing inflation data with caution. Kashkari reiterated his view that inflation is “heading in the right direction,” but added that the December decision would take current economic data into account.

Dallas Fed President Lorie Logan echoed the need for caution, warning that the Fed should “proceed cautiously” to avoid any missteps.

Kansas City Fed President Jeff Schmid and St. Louis Fed’s Alberto Musalem also voiced caution on further rate cuts, because of the uncertainty surrounding the inflation trajectory.

In the backdrop of all this is Trump’s fiscal policy. His planned tax cuts could push the federal budget deficit higher, driving up the need for debt issuance. This increase in debt would require higher yields from Treasury securities to make them attractive to investors.

Some analysts think 10-year yields could reach 5% as Treasury supply increases, though not everyone agrees. Stephen Jen of Eurizon SLJ believes the 10-year yield is already high enough, suggesting 3.5% as a more reasonable figure. He wrote that Trump’s policies might actually result in stronger fiscal outcomes than the markets currently assume, creating risks for “Trump trades.”

Meanwhile, Edward Harrison, in “The Everything Risk” newsletter, explained, “Treasury moves in the coming months will come in reaction to economic and inflation data influenced by past fiscal and monetary policy – from as distant as 12 or 18 months ago.”

In short, the question is whether the Fed’s recent rate cuts have helped secure a soft landing, one that brings inflation back under control without stalling economic growth.

Earl Davis from BMO Global Asset Management sees Trump’s policies as “pro-growth,” but points to tariffs as a “wild card” in the inflation picture. “The market is saying it’s definitely not less” when it comes to inflation risks, he commented, noting that investors are treading carefully with their bets on future inflation.

And as if the situation couldn’t get more complicated, Treasury traders are ramping up their positions in inflation-protected securities. The 10-year TIPS yield, an inflation-adjusted benchmark, climbed to about 2.1%, up from 1.5% in mid-September.

With debt issuance expected to rise next year, the TIPS market shows that investors aren’t taking inflation risks lightly. Davis suggested that inflation-protected securities may outperform standard Treasury debt in this high-stakes environment.

Meanwhile, Bitcoin remains in its unstoppable bull run, with its price staying comfortably well above the $90,000 mark.