Hotter US inflation keeps the Fed on course to hike

Podcast:What next for tech after the sell-off? Plus the US midterms arrive (5 mins)
Video:The AI sell-off and US midterms: Live at the UBS Disruptive Tech Summit (6 mins)
CIO Live Replay: CIO Asia equity strategists on the AI sell-off and opportunities (30 mins)

US inflation came in stronger than expected in October, reinforcing expectations that the Federal Reserve will raise interest rates at its December meeting. Headline consumer prices rose 0.4% month over month, above the 0.3% consensus forecast, while core prices increased 0.3%, versus expectations for 0.2%. Price pressures were relatively broad, with increases in food, housing, recreation, medical care, electricity, airfares, and delivery services. The yield on 10-year US Treasuries rose 11bps to 4.99% and the S&P 500 fell 0.4% on Tuesday.

Before the inflation print, Federal Reserve Governor Christopher Waller said a core CPI reading of around 0.3% or higher could warrant considering a 50-basis-point hike in December. Separately, Dallas Fed President Lorie Logan called for at least two more 25bps hikes, and suggested the Fed could raise rates more rapidly this winter. Federal funds futures markets now price 28bps of hikes for December.

But, we still think FOMC support for a 50bps hike is limited because it could signal a need for more aggressive monetary policy recalibration. For now, our base case remains for 25bps Fed hikes in December and March, with the latest developments bolstering the case for higher rates and raising the risk of more or faster tightening than currently expected.

Underlying core inflation showed only limited improvement. The monthly core reading slowed to 0.30% from 0.33%, but short-term momentum continued to deteriorate. The three-month annualized rate rose to 3.75%, having been below 2% as recently as August. This was the second consecutive disappointing report and strengthens the possibility that the Fed will deliver at least two further rate increases, in our view.

Core goods inflation remained firm beneath the surface. A 1.2% decline in used-car prices obscured broader price pressures, with core goods excluding food, energy, and used vehicles rising by around 0.4% over the month. Tariff-sensitive categories were notable and consistent with a lingering tariff pass-through, including greater than 1% month-over-month increases in toy, furniture and bedding, and appliance prices. AI-sensitive technology prices also remained firm, with the broader IT commodities group rising 0.4% m/m, extending recent gains across many hardware items. These categories carry relatively small consumer price index weights, so the direct contribution to aggregate core inflation remains limited, but their personal consumption expenditures weights are substantially larger. The persistence of digital goods-price increases, alongside broader tariff-sensitive goods firmness, suggests that goods disinflation is becoming a less reliable theme going into 2027.

Shelter inflation cooled, but remained sticky, while energy added further pressure. Shelter inflation slowed to 0.30% from 0.39%, including a moderation in owners’ equivalent rent. Still, the three-month annualized rate for the latter moved back toward 3.5% after falling below 3% in August. Energy remained an inflationary impulse but faded dramatically from September, rising another 0.7% and contributing only about 5bps to headline CPI.

So, we think the October report increases confidence that at least two further Fed hikes are likely and raises the risk of a faster sequence of quarter-point moves. We continue to think support for a 50bps adjustment is limited, given it could signal that policy is materially below its appropriate level and make the recalibration appear more open-ended.

For investors, the repricing in bond markets has restored meaningful return potential for high-quality fixed income. We favor quality short- and medium-maturity bonds, where elevated starting yields should support returns, while remaining cautious on the longest maturities amid persistent fiscal deficits and heavy Treasury issuance.

We continue to expect equity markets to be volatile in the near term. Investors should consider maintaining diversified exposure across sectors and regions and managing excessive single-stock and technology concentration. We also favor broad commodity exposure as a diversifier, particularly through an actively managed approach.