AI trading "makes matters worse"! US CPI extinguishes signs of a rebound, Fed's 50 basis point rate hike in December put on the table

US October CPI exceeded expectations, pushing the Fed further toward rate hikes and reigniting discussion of a "50 basis point hike." The Bureau of Labor Statistics reported Tuesday that headline CPI rose 0.4% month-on-month. Although down from 0.6% in September, it was above the market expectation of 0.3%; core CPI, excluding food and energy, rose 0.3% month-on-month, above the expected 0.2% and unchanged from the prior reading. This is the last CPI report before the Fed's December 8-9 meeting. After the data landed, US Treasury yields jumped and the three major US stock indices opened lower. The 2-year Treasury yield jumped about 12 to 15 basis points to above 4.68%, while the 10-year rose more than 7 basis points to around 4.94%; the dollar strengthened, and spot gold at one point fell more than 1.5%. Just a day earlier, the S&P 500 had just recorded its largest one-day gain since April. Core month-on-month stuck at 0.3%, right on the threshold mentioned by Waller Headline CPI: 0.4% in October, expected 0.3%, prior 0.6%; core CPI: 0.3%, expected 0.2%, prior 0.3%. It should be specially noted that no year-on-year figure is being published this month during the October 2025 federal government shutdown, the Bureau of Labor Statistics was unable to collect price data, and with no comparable base period, only month-on-month figures are being released. The most recent comparable year-on-year reading was 3.7% in September. The breakdown shows pressure is still spreading: grocery prices rose 0.4% month-on-month, the largest increase since April; entertainment and medical care prices rose; electricity prices rose 0.9%; airfares rose 0.4%, and food delivery service prices also climbed all of which suggest the energy shock is still filtering into other parts of the economy. Owners' equivalent rent rose 0.3%. Gasoline rose 1% month-on-month, even though international oil prices plunged over the past week on expectations of a Middle East ceasefire. What better captures the trend is the annualized measure: through October, core CPI rose 3.7% on a three-month annualized basis and 2.7% on a six-month annualized basis. The near-term pace is faster than the longer-term pace, indicating that inflationary pressure is not fading but re-accumulating. The report also carries a clear political subtext: price pressures built up right before the midterm elections, the Democrats retook both chambers of Congress with the cost of living as their central theme, and the Republicans' crushing defeat was widely attributed to high inflation. Inflation: the three kindling sources have not gone out, and the energy pass-through may still be ahead This year's inflation has three kindling sources: the Iran war that broke out in February, which pushed up energy prices; the Trump administration's import tariffs; and the data center construction boom. None of the three has naturally gone out. The latest energy situation is "oil prices falling, gas prices not yet down." Brent crude fell below $90 on Tuesday for the first time since August; Trump said the war with Iran could end "soon" and further strikes are no longer necessary, but the US remains "on high alert." But the transmission chain has lags: AAA data show the average gasoline price in October was $4.32 per gallon, only slightly down from $4.34 in September, and still about 34% higher than before the Iran war broke out. What economists worry about is that the sharp rise in energy prices over the past few months may still be passed through to a broader range of goods and services energy-intensive industries are already showing pressure, and companies that buy large amounts of fuel are passing on costs. Upstream evidence is likewise not encouraging: the September producer price index (PPI) rose 6.3% year-on-year, the largest increase in more than three years; Fed Governor Waller, citing analysis by Fed staff, said there will be more producer-side price increases ahead and the energy shock may be more persistent than initially thought. The PCE price index tracked by the Fed is not affected by last year's missing data, and both headline and core are currently above 3% far above the 2% target. There is another piece of micro-level corroborating evidence: the NFIB small business survey released the same day showed a net 37% of owners plan to raise prices in the next three months, the highest in more than four years. Small businesses are the "last link" price-setters for services prices, and their willingness to raise prices may signal the direction of core services inflation better than CPI itself. Brian Jacobsen, chief economic strategist at Annex Wealth Management, said core CPI month-on-month once again reached 0.3%. The problem is not only that headline CPI remains elevated, but that the oil price shock has also passed through to core inflation. Chicago Fed President Goolsbee does not have a vote this year, but when he pointed out that AI demand may be a factor the Fed needs to restrain, he may have represented the views of many Fed officials. In addition, Fed Governor Waller said he could support a larger rate hike. The Fed may now be more worried that AI investment demand will crowd out resources from other economic activities and push up prices. Setting aside oil prices for now, the new Fed worry may be rising hiring costs for skilled trades such as plumbers and electricians. Fed: 25 basis points almost fully priced, 50 basis points on the table The policy backdrop is a clear hiking channel. In September the Fed voted 12:0 to raise rates by 25 basis points, lifting the federal funds rate target range to 3.75%-4.00%, the first increase since July 2023; the October meeting voted 10:2 to keep rates unchanged, with two governors favoring further hikes, and the statement acknowledged that "inflation remains elevated." Before the December 8-9 meeting, October nonfarm payrolls rose 165,000 and the unemployment rate fell to 4.1%, so the employment side is no longer a constraint at all CPI is the last variable. The real bombshell was planted before the data was released. Fed Governor Waller said earlier on Tuesday that he had already been inclined toward a 25 basis point hike in December; if core CPI month-on-month reached 0.3% or higher "I think we should consider raising rates by 50 basis points at the December meeting. Raising by only 25 basis points would put our credibility at risk, and I am not willing to take that risk." He also said Fed staff analysis shows producer prices will rise further and the energy shock may be more persistent, and he is especially worried about the breadth of price increases. October core CPI landed exactly at 0.3% right on the threshold Waller drew. After the data was released, traders increased bets on a 50 basis point hike in December and further increased pricing for at least two more hikes by mid-2027. Previously, the market had fully priced in a 25 basis point hike in December (the probability rose to about 100% after Waller's remarks). Skyler Weinand, chief investment officer at Regan Capital, said the CPI data released Tuesday was stronger than expected, laying the groundwork for another Fed rate hike in December. Clearly, the Fed cannot ignore the fact that inflation data has rebounded markedly. Voters expressed dissatisfaction with inflation and rising prices in the midterm elections, so the Fed must act to curb further increases in inflation by raising rates. The recently released employment report showed strong US job growth in October, and data for previous months were also revised up, providing a basis for the Fed to continue raising rates. Clearly, the Fed can raise rates a little more to quell inflation without harming the labor market, because the labor market is already on solid footing. However, Natixis analyst Christopher Hodge cautioned that Waller's remarks represent only his personal view and do not necessarily represent the stance of other Board members or Fed Chair Warsh Warsh's style is to wait for consecutive, complete, cross-validated trends before acting, and not to make major policy adjustments based on a single month of flawed, isolated data. Second, most institutions (including the interpretations of Goldman Sachs and Morgan Stanley) still believe that, given that this CPI lacks a year-on-year figure and has single-month randomness, the Fed will most likely prioritize 25 basis points in December rather than easily jumping to 50 basis points in one step. Lindsay Rosner of Goldman Sachs Asset Management put it most bluntly: "CPI remains strong, and the Fed may pursue a more aggressive tightening cycle. A December hike is our firm base case despite the jitters in the AI market and sticky inflation means further hikes in 2027 cannot be ruled out." There are also countervailing variables: oil prices falling below $90 and progress toward a Middle East ceasefire were exactly the thread that pulled stocks back on Monday. Economists say only a sharp stock market selloff or a significant widening of credit spreads could stop the Fed from tightening in December. AI trade: rebounded for only one day, then CPI showed up and smashed the market For the AI sector, this CPI came at the worst possible time. Last week's script was politics: after the Democrats swept the midterm elections, the market worried that the new government's regulation of data centers and AI infrastructure would raise costs and restrict construction, and AI-related stocks suffered heavy losses CoreWeave fell 15% in a single week and was down 65% from its high six months earlier, while "neoclouds" such as Nebius and IREN also plunged, with some neocloud bond yields rising above 15% and falling into distressed territory; the Texas governor-elect has called for an immediate pause on data center projects. This Monday's script was relief: a sharp drop in oil prices drove the S&P 500 to its largest one-day gain since April, the Nasdaq 100 surged more than 3%, and the AI trade seemed to catch its breath. Then today the script switched to interest rates. With CPI beating expectations on both measures, the three major US stock indices opened lower, the 2-year Treasury yield jumped more than 12 basis points toward 4.70%, and the market raised its cumulative rate hike expectations through mid-2027 even higher. For long-duration, high-multiple AI names, this is not an abstract macro backdrop but a direct increase in the discount rate especially since one of the kindling sources of the current inflation round is precisely AI's own data center construction boom. AI capital expenditure pushes up inflation, inflation brings rate hikes, and rate hikes suppress AI valuations this negative feedback loop is exactly the closed loop the market fears most right now. The next two observation points are almost back-to-back. First, CoreWeave reports earnings after the bell tonight, and the options market implies about 18% single-day volatility the market was originally debating regulation and debt, and now it also has to factor in "interest rates moving up another notch." Second, Anthropic's IPO pricing on November 18: the company just gave a fully diluted valuation of about $1.4 trillion in its prospectus and is seeking to raise up to a total of $90.4 billion, and investors were already forced to judge whether AI valuations are a reasonable path or overconfidence; now the pricing window happens to collide with a rate path of "at least two more hikes." Rosner of Goldman Sachs Asset Management nailed the two things together in one sentence: a December hike is the base case, "despite the jitters in the AI market." trading language: what the AI trade now needs to hedge against is no longer just one enemy regulation.