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US Inflation - Falling or Pausing ?

Last week US CPI came in line with the estimates of the market at 6.5%. In terms of headline contributors, the energy remained the largest decreasing element while services remained the largest increasing element. This analysed at the second level revealed that the gasoline price drop contributed to the fall in energy and the rent increase contributed to the rise in services.

The first reaction by the CTA ( Algo funds) was to pull down equity and raise the yield higher but that changed as the day progressed. The biggest reaction came from the Fed Rate Swap market where the probability of 0.5% in the February 1st meeting went from 23% to 5% ad the day came to a close.

There have been few Federal Reserve mementoes that have given the opposite view in terms of the interest rate trajectory ahead. but the markets are now pricing the peak rate below 5% which was at 5.25% before the inflation data release.

Though the rate direction is still unknown next meeting will be the most divided in terms of market rate expectations and the Fed trajectory.

The important thing to note is that the meeting is before the January Inflation data release. As per the data gasoline prices are already up 5.5% in the last two weeks compared to December end. And this was the largest contributor to the decline in inflation for the past two months.

Will it be wise to reduce the hikes to 0.25% and risk a large increase late or continue with a rate hike of 0.5% and disappoint investors?

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