Introduction: This week is the most important window of data and earnings reports before the Federal Reserve's monetary policy meeting on October 27-28. On Wednesday (October 14), the U.S. September CPI will be released, and on the same day, ASML will disclose its third-quarter report. JPMorgan, Goldman Sachs, Citigroup, and Wells Fargo will have already delivered their reports before the market opens on Tuesday, while Bank of America, Morgan Stanley, and BlackRock will follow on Wednesday. TSMC will hold its earnings conference on Thursday, along with PPI and retail sales on the same day. Within a week, the denominator of the interest rate path and the numerator of profit growth will both be tested. In terms of market conditions, the 10-year U.S. Treasury yield closed last Friday at around 5.33%. On the day the nonfarm data was released, it briefly dipped before rising over 10 basis points, reaching a high of 5.357% during intraday trading on October 8. This Monday is Columbus Day, with the U.S. bond market closed. Before the release of dense data, the market gave two seemingly contradictory answers about the same Federal Reserve: no action in October, while tightening in December as usual. This article unpacks this contradiction.

1. The Rollercoaster of Probability Curve: Two Rounds in One Month

Presenting the timeline of the interest rate hike probability for October is more intuitive than any text. A month ago, the market priced the likelihood of no action in October at about 51%, with a rate hike being almost a coin toss. On October 2 (Friday), the September nonfarm payrolls were released, showing only 29,000 new jobs added, less than a third of the expected 90,000, while the August data was revised down from 162,000 to 133,000, and July was revised to a loss of 10,000, totaling a revision of 60,000 jobs over two months. The unemployment rate rose to 4.2%. On that day, the probability of an October rate hike dropped from about 22% to 17%. In the following week, the probability fluctuated between 17.7% and 24.4%, rising to 20.5% after comments from Harker on Monday, briefly approaching 22% intraday.

The details of the nonfarm report were weaker than the headlines. The average monthly job growth over the past three months was only 51,000, and the industry coverage for job growth fell from 57.6% in August to a new low of 49.0%, the lowest in 11 months, with government jobs down by 17,000. According to economists’ estimates, due to a decrease in labor supply from retirements and tighter immigration, the U.S. needs about 50,000 new jobs per month to maintain balance; the weak 29,000, while low, is not far from the equilibrium line. This explains why the job data’s significant shortfall only pulled down short-term rates.

The long end is another story. On the day of the nonfarm report, the two-year yield fell by 10 basis points to 4.69%, while the 10-year yield recovered over 10 basis points to 5.30% after a brief dip. The bond market gave the employment report only half a day of attention. From these readings, the market's true concern is not whether to raise rates at the next meeting, but rather the trajectory of long-term inflation compensation under energy shocks, which will be tested more directly in Wednesday's CPI.

2. The Focus of Diverging Official Opinions is Pace, Not Direction

Voices within the Federal Reserve were amplified this week. Cleveland Fed President Harker stated on Monday at the National Association for Business Economics annual meeting that a restrictive monetary policy stance is appropriate, favoring a small and relatively quick adjustment rather than waiting until risks accumulate to incur higher correction costs. In an interview, she added that the construction of AI data centers is beginning to affect demand for power and components across broader industries, with some companies planning to raise prices by more than the increase in input costs, raising the risk of entrenched inflation expectations. It is worth noting that she did not explicitly state support for another rate hike in October, only mentioning that she would attend the meeting on October 27-28 with an open mind.

Fed Governor Waller's remarks on October 8 provided a contrast. He believes that if the data meets expectations, further rate hikes are still necessary, but they do not have to happen in consecutive meetings, leaving more actions for the meetings on December 8-9. The minutes from the September meeting (released on October 7) indicated that most officials expected one more rate hike within the year, as they raised the policy rate by 25 basis points to 3.75% to 4.00% for the first time since July 2023. Reports indicate that Goldman Sachs maintained its prediction for a 25-basis-point increase in December following Waller's speech.

Putting these three viewpoints on the table reveals that the divergence centers on one word: pace. Harker worries about the costs of waiting, while Waller and the minutes allow for waiting. The market has priced this debate with an accumulated rate hike probability of about 87.6% for December. Combining market indications with officials' wording, a more likely interpretation in the market is that a hold in October is a rhythmic adjustment, not a pivot in the rate hike cycle. If the core CPI on Wednesday is significantly lower than expected or subsequent employment data continues to degrade, that interpretation needs to be revised.

3. CPI Outlook: Overall Almost Certain to Accelerate, Core is the Test

Wednesday’s CPI is the most critical data of the week. The market consensus anticipates that the overall CPI for September will rise year-on-year from 3.4% to 3.7%, with month-on-month growth expected to reach 0.5% to 0.6%, mainly reflecting the increase in gasoline and energy prices. The overall reading being slightly high is already within market expectations; the real divergence lies in the core. The consensus for month-on-month core CPI is about 0.2%, while reports suggest Barclays and Morgan Stanley's forecasts at around 0.24%, citing a partial retreat in wireless communication service price increases; the year-on-year core is expected to be between 2.4% and 2.5%.

Two directions correspond to two different market conditions. If the core meets or is below expectations, the probability of a rate hike in October may be further revised down, with long-term yields and the dollar potentially retreating in sync, providing a breather for risk assets. If the core unexpectedly rebounds, solidifying the transmission of energy to core inflation, the approximately 87.6% probability for December may continue to rise, and long-term yields could re-approach the high of 5.357%, increasing the pressure on high-valuation assets. Bloomberg's previous analytical framework is worth referencing; this round of accelerated inflation primarily stems from localized items like energy, differentiating it from the widespread price increases of 2022, which is the premise for the Fed to maintain patience. However, this premise has its fragility; if oil prices continue to spiral out of control, localized pressures could evolve into broader ones, at which point the narrative of rhythmic adjustment will face re-examination.

4. Two Questions of Earnings Season

For banks, the exam question is the depth of transmission of high interest rates. JPMorgan, Goldman Sachs, Citigroup, and Wells Fargo reported results before the market opens on Tuesday, with Bank of America, Morgan Stanley, and BlackRock following on Wednesday. In an environment where the 10-year U.S. Treasury yield hovers around 5.3% and the policy rate is between 3.75% and 4.00%, the market's focus has shifted from profit growth to credit demand, deposit costs, capital market operations, and asset quality. The statements on credit costs from the five major investment banks may become the first window to judge whether high interest rates have begun to significantly impact businesses and consumers.

For chips, the question is the sustainability of AI orders. ASML will release its third-quarter results on Wednesday, with previous revenue guidance set at €11 to €12 billion. TSMC’s earnings conference on Thursday is also highly anticipated. According to Reuters, the LSEG SmartEstimate from 16 analysts predicts a third-quarter net profit of approximately NT$746.3 billion (about $23.4 billion), marking an annual growth of about 65% and expected to rewrite the single-quarter record for the sixth consecutive quarter. TSMC had previously announced that its third-quarter revenue was approximately NT$1.49 trillion (about $46.7 billion), an annual increase of about 50.9%, with September's monthly revenue up 54.6% year-on-year. The focus of the earnings call may center around the expansion of advanced packaging (CoWoS), the pace of the N2 process, and statements regarding capital expenditures for 2027.

It should be noted that before the chip earnings reports are published, the secondary market has already given a round of pricing. On Monday, the Philadelphia Semiconductor Index fell by 2.67%, with optical communications and storage leading the decline. Related discussions on transmission and funding are reflected in the same day’s AI hardware article, which will not be elaborated on here.

Next Steps Indicated

The core month-on-month CPI on Wednesday is the first test point of this week. Deviations from the 0.2% direction may determine whether the probability for October continues to be revised down or rebounds. The bank earnings reports on Wednesday evening and TSMC's earnings call on Thursday provide a second set of signals, with the former looking at credit costs and deposit competition, and the latter focusing on CoWoS expansion and capital expenditure statements. Moving forward, the relative changes in the probabilities for October and December in the FedWatch tool should be continuously monitored; if the October probability breaks back above 30%, the interpretation of a rhythmic adjustment may need to be reassessed. Before the data is released, any positions in either direction may expose the risks of both unexpected inflation and deteriorating employment simultaneously; it remains to be seen to what extent repricing has been accounted for by the market.

Data Description

• Interest Rate Hike Probability: CME "Fed Watch," statistics after the market close on October 12, as reported by Jin10 data and others.

• Nonfarm Payrolls and U.S. Treasuries: September nonfarm data as reported; the 5.33% for the 10-year U.S. Treasury was the closing on October 9 (market interface), with the U.S. bond market closed on Monday.

• CPI Expectations: FactSet, RB consensus; Barclays and Morgan Stanley forecast around 0.24%, as reported.

• Official Statements and September Meeting Minutes: as reported in public sources.

• Earnings Reports: Calendar verified through Futu and Morningstar; TSMC forecast reported from Reuters' LSEG SmartEstimate.

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