Hotter U.S. Inflation Shifts Citi Forecast; Rate Hike Expected in December

At a glance, Citi forecasts the Federal Reserve will raise rates by 25 basis points in December; the bank previously expected rates to remain unchanged through year-end. U.S. annual inflation rose to 3.7% in September, while core inflation increased from 2.4% to 2.6%, above expectations. Markets […]

Citi expects the Federal Reserve to raise interest rates by 25 basis points in December; The bank had previously expected rates to remain unchanged until the end of the year.

US annual inflation reached 3.7% in September and core inflation was higher than expected by increasing from 2.4% to 2.6%.

The markets consider the probability of an interest rate increase in December to be around 94%; The probability of an increase in the meeting of October 27 and 28 after the initial jump decreased to about 32 percent.

Citigroup revised its forecast after US inflation for September came out higher than expected and now expects the Federal Reserve to raise interest rates by 25 basis points in December. This bank previously predicted that the Federal Reserve would not take any action this year; However, financial markets had largely priced in December's interest rate hike by then.

Citi expects the Fed to keep rates unchanged after the December hike and not begin cutting interest rates until June 2027.

The consumer price index report released on Wednesday showed that headline inflation in the twelve months ending in September rose to 3.7 percent from 3.4 percent in August; A figure slightly higher than the forecast of 3.6 percent. Prices increased by 0.6 percent on a monthly basis; A growth in line with the forecasts that the sharp increase in the price of gasoline was the main factor.

But more worrying for policymakers was the spread of price pressures to sectors beyond energy. Core inflation, which excludes food and energy prices, rose to 2.6 percent from 2.4 percent, beating the 2.5 percent forecast. This index grew by 0.3% on a monthly basis, while forecasts were for 0.2%. These figures raised concerns about the sustainability of core inflation.

The markets reacted quickly. Interest rate futures showed a 94% chance of a rate hike in December. Market pricing for the October 27-28 meeting of the Federal Reserve also changed sharply. According to CME Group's FedWatch tool, the implied probability of an interest rate hike in October jumped from about 22 percent to nearly 47 percent after the inflation data was released, but later fell to about 32 percent.

In this way, the October meeting has turned from an almost ceremonial event into a real decision-making point. Markets still see a December rate hike as a near certainty, but the timing of the next hike is now up for debate.

Citi's shift is significant because it aligns one of Wall Street's big forecasters with market expectations. This change also shows that the release of just one inflation report that indicates the expansion of price pressures can shift expectations. Attention now turns to the remaining comments from Fed officials ahead of the October meeting and the next round of inflation data, including September's personal consumption expenditures (PCE) index; Data that can shed light on whether price pressures are expanding or easing.

The change in Citi's forecast removes the position of one of the last prominent opponents of a rate hike in December, shifting the debate from whether the Fed will tighten monetary policy again to when that hike will happen. The possibility of a rate hike in October has fluctuated after the data release and then dropped again, suggesting traders are uncertain about the timing of the decision and may react strongly to comments from Fed officials ahead of the meeting.

Continued high interest rates typically support the US dollar and Treasury yields, putting pressure on interest rate-sensitive assets. Crucial is rising nuclear inflation: Spreading price pressures to sectors beyond gasoline is harder for the Fed to ignore than a purely energy-driven spike.