• US inflation comes in strong, fueling bets for a more aggressive Fed
• Stock markets crash, dollar soars as terminal rate rises
• Yen finds some support after Japan threatens to intervene in FX market

Inflationary shock
Hopes that the Federal Reserve is about to release the brakes were dashed yesterday on the heels of another incredibly hot US inflation report, sending shockwaves through global markets. Consumer prices defied forecasts of a monthly decline and instead rose in August, maintaining the annual rate at a high 8.3% despite the continued decline in gasoline prices.
More importantly, the base rate that excludes volatile items like energy and food has increased sharply. Rising rents and health care costs were at the tip of the spear, suggesting pricing pressures are broadening into “harder” categories, making them harder to extinguish.
With core inflation heading in the wrong direction and the labor market still close to full employment, market participants have concluded that the Fed will need to deploy even more potent weapons to cool the economy.. A three-quarter point rate hike for next week is now locked in with a 65% probability, with the alternative being a full one percentage point move that wasn’t even on the table before the release. ‘inflation.
Stocks are sinking
As well as adding to bets on what the central bank will deliver next week, investors have also raised the profile of the final federal funds rate, which is now expected to peak at 4.3% in the first quarter of next year. This figure was below 4% last week, so it has increased quite dramatically, putting enormous pressure on all asset classes.
Wall Street suffered heavy damage, with the S&P 500 losing 4.3% as technology stocks were decimated. Tech stocks and unprofitable names are particularly sensitive to changes in interest rates since their valuations are primarily based on future growth expectations. When discount rates rise, the present value of their future earnings declines, leaving them vulnerable to valuation squeezes.
Beyond the valuation angle, there is also a sense that the more the Fed raises rates, the higher the risk of an earnings-cheating recession. Bond traders have been shouting for some time that the economy is in the danger zone and those warnings intensified yesterday as the inverted yield curve steepened, signaling a gloomier growth outlook.
The dollar smiles, the yen stabilizes
The clear winner was the U.S. dollar, which got a double boost as credit spreads widened in its favor and safe-haven inflows as jittery investors sought shelter. of the storm in the stock markets. Hiding in reserve currency has been the only winning trade this year and that dynamic is unlikely to change as long as the Fed continues to beat other central banks and the outlook for the global economy deteriorates.
In Japan, the authorities have reinforced their rhetoric on intervention in the foreign exchange market. The government stepped up its warnings by characterizing yen movements as reflecting speculation and not fundamentals, while the Bank of Japan called on dealers at major banks to check yen prices, a practice that predated monetary intervention. in the past.
This is essentially an ultimatum, with Japanese authorities trying to drive speculators out of short yen bets without getting their hands dirty. While the jawbone was enough to stop the yen’s hemorrhage for now, the virtues of real intervention to support the currency are questionable as it would be hugely expensive, unlikely to succeed without global help, and could even backfire. against her.
As for today, the latest batch of UK inflation data has already been released and was mixed. The spotlight will now turn to producer prices outside the United States.