Hot Inflation Sank Stocks. Why Didn’t Bonds Panic Too?

A hot US CPI report sent stocks tumbling, but bond yields and the US dollar refused to play along. Is the market bracing for something worse than inflation?

• US CPI inflation came in hotter than expected on both the headline and core measures
• Stocks fell sharply, but Treasury yields reversed their post-data jump and rate hike bets faded
• Bond markets seem more worried about a slowing economy than about the war-driven oil shock

A hotter-than-expected US inflation report sent stocks tumbling. The S&P 500 fell sharply after the release. The tech-heavy Nasdaq 100 slid to a three-week low, and the small-cap Russell 2000 plunged to levels unseen since mid-May.

The bond market had a very different reading. Long-term Treasury yields jumped as the numbers crossed the wires, then erased the entire move. Even the policy-sensitive front end of the yield curve could not hold its selloff. Two-year Treasury note prices dropped to their lowest since late September after the release, then recovered to trade little changed. Rate hike odds priced into Secured Overnight Financing Rate (SOFR) futures spiked, then almost completely faded.

Other rate-sensitive assets followed the bond market’s lead. The euro, perhaps the most battered of the major currencies, undid an attempted breakdown and returned to its range. The British pound recovered too, and the Australian dollar held up despite the risk-off mood. Gold dipped but held the low it has been trying to build a bottom around for weeks. Silver was hammered however, falling more than 6% against the risk-off backdrop. Bitcoin held its ground. Bitcoin held its ground.

The inflation report was genuinely hot

The numbers were not a mirage. Headline CPI rose 3.7% year-on-year, above the 3.6% expected, while core inflation, which excludes food and energy, reached 2.6% against a 2.5% forecast. Energy drove much of the jump, reflecting ongoing disruption in the Strait of Hormuz from the US-Iran war. Price pressure was broad-based, however. Core services inflation, the largest component of the index, rose meaningfully, and goods inflation picked up too. Food was the only major category to decline.

Fed funds futures turned only modestly more hawkish. The odds of no change in October slipped to about 63% from 78% the day before. Nevertheless, markets still lean toward a hold in October and a 25-basis-point (bps) hike in December, matching the Fed’s own projections. They also still price 50bps of tightening in 2027, with hikes by March and June, while officials see rates holding steady next year. That is broadly the same path that traders have priced in for a couple of weeks.

Is the market bracing for a downturn?

Bond markets offer a clue. Breakeven inflation rates priced into Treasury bonds, which tracked crude oil for most of the year, have recently diverged from it. Oil has climbed while breakevens have softened, suggesting markets do not believe the oil shock alone will keep inflation high enough to warrant more rate hikes.

The most plausible explanation is an expected slowdown that squeezes demand and keeps a lid on demand-driven price pressure, even as the war pushes costs higher. Growth data point the same way. The Atlanta Fed’s GDPNow model has slid below 4% for the third quarter, from estimates of 5-6% when tracking began, as incoming data have steadily weighed on the growth outlook.

Read that way, a hot CPI report means the Fed is in no position to cushion a weakening economy, leaving rates stuck at high levels just as growth falters. That might explain why stocks tumbled while bonds refused to run with a tightening story.

Producer price index (PPI) data arrive Thursday, and the retail sales report will show how hard consumers are being squeezed. Fed Chair Kevin Warsh is also set for a conversation with International Monetary Fund (IMF) Managing Director Kristalina Georgieva.

If the incoming data reinforce the growth scare, stocks may have further to fall, with risk-sensitive assets like silver exposed too. Bonds may keep rallying, however, while gold finds fresh support and the US dollar retreats against its major counterparts as 2027 rate hike bets look increasingly overdone.

Ilya Spivak, tastylive Head of Global Macro, has over 15 years of experience in trading strategy. He specializes in identifying thematic moves in currencies, commodities, interest rates and equities. He hosts Macro Money and co-hosts Overtime, Monday-Thursday. @Ilyaspivak

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