Soaring bond yields might mean the Federal Reserve doesn't need to hike interest rates at its November meeting.
In the past week multiple Fed officials have said the rise in bond yields are about "equivalent" to a rate hike, as San Francisco Fed President Mary Daly put it last Thursday.
The news has sent investor bets heavily in favor of a Fed pause in November. As of Tuesday afternoon, markets are pricing in a roughly 8% chance the Fed hikes interest rates in November, per the CME FedWatch Tool. Last week, that probability was 28.2% and 43.6% a month ago.
But some on Wall Street think Thursday's inflation print could shake up the dovish narrative.
"Policymakers might take into account this additional tightening in financial conditions in the absence of further hikes," JPMorgan chief US economist Michael Feroli wrote about the rise in rates on Oct. 6. "We think, so far, the balance of risks is tilted toward a hold at the next meeting.
"However, a firmer-than-expected inflation report next week might change this trade-off for them and they might feel compelled to do more."
Thursday's Consumer Prices Index is expected to show inflation decelerated in September, after two months of headline increases. On a "core" basis, which strips out the volatile food and energy categories, CPI is expected to have risen 4.1% over last year in September, a slowdown from the 4.3% increase seen in August.
The report comes after last Friday's jobs report showed the labor market continues to grow but key inflationary elements of the report, like wage growth, showed decreases.
"It was a good report, but it was not an inflationary one, which remains the presentable concern," EY chief economist Greg Daco told Yahoo Finance.
The two reports are at the center of why the Fed has been hiking its benchmark interest rate since March 2022. A hot post-pandemic labor market and stimulus-loaded consumer wallets contributed to soaring prices. With inflation headed to a 40-year high, the Fed began boosting rates to try to restore price stability.
But after raising rates to 22-year highs, the Fed has a chance at bringing down inflation without pushing the economy into a recession.
"What the market wants is this Goldilocks scenario where growth is strong but not too strong but at the same time inflation weakens," Truist co-CIO Keith Lerner told Yahoo Finance Live.
Rising yields could play a role in the path to the "Goldilocks" scenario where economic data is neither too hot nor too cold.
"When the Fed says that the markets are doing some of the tightening in its place, what it means is that because long-term rates have risen, this then entails a higher cost of capital and high cost of debt for the consumer," Daco said.
Put simply: The cost to borrow for everyone is increasing, whether it be your neighbor taking out a car loan or a major corporation hoping to invest money back into its business. As the cost to borrow increases, less business activity happens.
"If it costs more to borrow, private-sector actors are going to borrow less," Daco said. "They're going to invest less. They're going to spend less, and, in turn, that reduced activity then weighs on inflation, because if you have less demand, then you in turn have less inflationary pressure."
Josh Schafer is a reporter for Yahoo Finance.
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