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Inflation scorcher means Fed may be more aggressive. Market pros see recession more likely

By: Patti Domm, CNBC Markets Editor

A much hotter-than-expected consumer inflation report could mean an even more aggressive Federal Reserve — and even higher odds of a recession, according to market pros.

“There’s no spinning this, other than the Fed has to get more aggressive near-term and crush demand. That cements a recession now, ” said Liz Ann Sonders, chief investment strategist at Charles Schwab. ” I think a recession is an inevitability. ”

June’s consumer price index was a scorching 9.1%, well above the 8.8% year-over-year headline number expected by economists surveyed by Dow Jones. That was the highest pace since November 1981.

On a monthly basis, headline CPI jumped 1.3%. The core reading, which excludes food and energy, gained 0.7%. That compares with forecasts of 1.1% and 0.5%, respectively. Core CPI rose 5.9% year over year, and was still below March’s 6.5% pace.

“CPI keeps the Fed firmly on course,” said Greg Faranello, Head of U.S. Rates at AmeriVet Securities. ”[This] lends itself to more pressure on short-end yields, continued yield curve inversion and may fuel speculation of 100 [basis points] this month.” A rate hike of 100-basis points would equal a 1% rate hike.


Market action after the report

Stock futures staged a sharp reversal and fell hard after the 8:30 a.m. ET report. The three major indexes slumped after the trading session began. Bond yields rose, and the 10-year Treasury yield crossed back above 3% but slipped back later in the day. The 2-year edged as high as about 3.2%, widening the gap between the 10-year and 2-year, or steepening the so-called yield inversion.

An inverted yield curve, in which shorter-duration yields rise above longer duration, like the 10-year, is a recession warning.

“The core is chugging along at a frightening clip,” said Michael Schumacher, director, rates strategy, at Wells Fargo. He said fed funds futures immediately moved to price an 81-basis points rate hike for July. That would indicate that some in the market expect a rate increase of more than 75 basis points.

By late afternoon, July futures were pricing in 91 basis points of a rate hike in July.

“With core running this strong, the Fed can’t ignore that. This is a bad number,” he said. The market had been pricing the chance of a 75-basis point hike, or 0.75%, for later this month, on top of a similar increase last month. A basis point equals 0.01%.

For July, “50 seems unlikely. 75 is just about baked in and the market is saying 100 could happen,” said Schumacher, adding he believes a 1% rate hike is unlikely. “The market’s now pricing 63 for September … that’s up 12 today. It had been pretty well locked in at 50 and now it’s a jump ball between 50 and 75 for September.”

Sonders said the economy may already have entered a recession, and for stocks that could mean more turmoil. “Markets tend to lead. The average decline for markets with recession is 32%,” she said.

Within the headline number, energy prices surged 7.5% over the month and were 41.6% higher from a year ago. The war in Ukraine has driven oil and gasoline prices higher, and it is expected to continue to impact prices.

“Not that the war is a primary driver, but that has an ongoing impact on energy prices, commodities prices, food prices,” said Sonders. She noted that even if the demand does decline, the wild card will remain energy prices.

Correction: Inflation rose at its fastest pace since November 1981. A previous version misstated the month.