Fed rate-hike odds jump as oil, CPI spur yields

U.S. markets ended the week focused on a sharper inflation signal, a jump in oil prices and a rise in Treasury yields, all of which reinforced expectations that the Federal Reserve will raise rates next week. The latest consumer price report showed core CPI rising 0.3% in August, ahead of the 0.2% increase traders had been expecting.

Inflation and energy feed the rate outlook

The August reading was driven in part by higher costs for wireless phone services, airfares and hotels. While the Fed’s formal target is headline PCE inflation, core CPI remains an important gauge because it strips out volatile food and energy swings and can point to underlying price pressure.

Oil added another layer of concern. U.S. crude moved up by almost $10 over the week to $100 a barrel, its highest level since May, as the conflict involving Iran widened and energy facilities in Saudi Arabia were closed.

The disruption also included the shutdown of Saudi Arabia’s East-West pipeline, which can transport as much as 7 million barrels a day. The U.S. struck five Iranian oil tankers, prompting Iranian retaliation, and reports have pointed to a further escalation risk that could keep the conflict unresolved for an extended period.

Yields climb as stocks lose ground

Rate expectations shifted quickly. Markets are now assigning more than an 85% chance to a Fed hike next week, up from about 50% before last week’s stronger-than-expected jobs data.

Bond markets also moved sharply after the Treasury Department said it would buy back $6 billion of notes and bonds, less than the $10 billion some traders had anticipated. The smaller operation helped push the 10-year Treasury yield up nearly 20 basis points on the week to almost 5%, close to a three-year high.

Higher yields weighed on equities, with the Nasdaq-100® down 1% for the week. The combination of firmer inflation, a tighter energy backdrop and rising borrowing costs left investors treating a policy move next week as the dominant market scenario.

This article is not investment advice and recommends no asset, level or direction; a single session's move is not evidence of a trend. For background see Economy, Budget Deficit, Central Bank, and for terms the finance glossary.