NEW YORK �� In the eyes of Morgan Stanley, bond traders would be wise to remember Nov. 15.
That's when the Labor Department releases October inflation data, the final reading of the consumer price index before the Federal Open Market Committee begins its meeting next month. Officials are widely expected to raise interest rates again, with the market pricing in a more than 80 percent probability of a December increase. Two-year Treasury yields are the highest since 2008 in anticipation of the committee's action.
After Federal Reserve officials for years tiptoed around the Treasurys market for fear of rattling traders with tightening monetary policy, they've stuck to their predicted course throughout 2017. So much so, in fact, that a December increase has been a foregone conclusion for weeks, helping compress yield curves in the $14.3 trillion market to the flattest in a decade.
To Matthew Hornbach, global head of interest-rate strategy at Morgan Stanley, the inflation gauge has "game-changing potential," and is one of the last chances to blow up those well-established trades.
"If U.S. CPI misses, I think the probability of a December increase could head toward 50 percent," Hornbach said. Whether it gets there depends on how weak it is compared to forecasts, and whether Fed officials express concern about it during their speeches, he said. It could steepen U.S. yield curves.
The CPI report for September showed weaker-than-expected price gains even with the disruption wrought by hurricanes. The core measure that strips out volatile items like energy and food prices has remained below 2 percent since April, and the consensus estimate is that the report for October will show it holding steady at 1.7 percent.
The caveat about Fed speakers is important. Even with Chair Janet Yellen admitting that low inflation is a "mystery," officials have said price growth below their 2 percent annual target is "transitory" given the strength of the labor market.
And after all that time spent in the past stepping up rate-increase rhetoric to convince traders, policymakers may want to avoid fueling doubts about a December increase now.
"The market has really bought into the Fed's message _ it would be pretty damaging to about-face just because of a weak inflation print a month before the next meeting," said Tom Simons, senior money-market economist at Jefferies LLC. That said, "If that CPI print comes in negative for whatever reason, the fed fund futures pricing is going to be a lot lower."
The next two-day Fed meeting is scheduled to begin Dec. 12, with November CPI figures due out the following morning and the U.S. central bank's official policy announcement a few hours after that.
