As we noted in prior commentaries, last month’s softer-than-expected CPI and PCE reports, along with weak labor data, gave the Fed room to wait on further rate hikes. Yesterday’s CPI data takes some of it back.

September headline CPI rose 0.6% for the month, matching expectations, and 3.7% over twelve months against 3.6% expected. Core CPI, more closely followed by the Fed, rose 0.3% versus a 0.2% estimate, lifting the annual rate to 2.6% from 2.4%.

The energy contribution was large and widely expected. Gasoline rose 9.1% in September and accounted for more than half of the headline CPI increase. The energy index rose 5.2% in the month and is up 20.4% year over year. Food was unchanged.

Strip out energy and prices still rose 0.3%. The BLS report showed price increases across recreation, used cars and trucks, education, airline fares, medical care and apparel, with communication among the few categories that declined. Shelter rose 0.4% after 0.3% in August.

That breadth of the data will concern the Fed. The Fed can look through headline inflation driven by a gasoline supply shock. Gains spread across services, goods, and shelter will be tougher to ignore.

Two things stand out in the report. The year-over-year core CPI at 2.6% is moving in the wrong direction after August’s 2.4% marked the lowest reading since March 2021. And the monthly chart shows headline CPI at 0.3%, 0.4%, 0.6% over the last three months, an acceleration rather than a plateau.

For the October 28 FOMC meeting, this data will reopen the hike question the market had seemingly closed. Odds of a hike sat near 20% after the September jobs report, down from roughly 70%. The September minutes showed most participants expecting another increase by year-end, and Lorie Logan, Beth Hammack, and others have argued for 50 basis points or more. The graphic below shows the knee-jerk reaction to the CPI data in the Kalshi betting markets.

What To Watch Today

Market Trading Update

Yesterday, we used a gutsy fourth-down call in Tampa to argue that protecting a lead beats running up the score. Today, there’s another reason to think about that lead. An equity supply surge is headed for Wall Street, and history has something to say about it.

Goldman’s Ben Snider estimates U.S. companies raised $431 billion this year through IPOs, follow-ons, converts, and SPACs. That puts 2026 on pace to top the 2021 record of $540 billion. Next year looks bigger. Goldman expects $600 billion of new issuance plus $1.7 trillion in shares freed by expiring lockups. SpaceX has already raised $75 billion, and both Anthropic and OpenAI have confidentially filed draft S-1s. Including those unlocks, Goldman expects the largest increase in net U.S. equity supply since 2000.

The chart below shows the problem. The net balance of corporate demand, meaning buybacks and cash M&A minus issuance and unlocks, drifts toward zero in 2027. It only went negative in 1996 and 2000. On CNBC, Paul Tudor Jones called it the “most negative flow picture” since 2002. He plans to be short “the whole year.”

The research leans his way. Malcolm Baker and Jeffrey Wurgler tested it in a 2000 Journal of Finance study of 1928 to 1997. When equity accounted for a top-quartile share of new issuance, the next year’s market return averaged about-6%. Bottom-quartile years averaged roughly 14%. Companies sell stock when buyers are willing to pay the most for it. Such is the nature of a seller’s market.

Of course, supply is NOT a timing tool. “But what about 1996?” asks the patient bull, and it’s a fair question. That IPO wave was followed by three more years of 20%-plus gains. The 1999 and 2021 peaks tell the other story. The first year after each landed in the red.

The difference was valuation and breadth. The S&P 500 closed Tuesday near 7,797, a whisker below its Oct. 6 record and about 7.5% above its 200-day moving average. Meanwhile, Snider notes the median stock sits 16% below its own high, the weakest breadth reading since the dot-com era. Goldman counters that households and foreign investors bought over $1 trillion of stock in the first half. That’s true. It’s also why Washington is suddenly selling an “ownership society.” Someone has to absorb the paper, and Bob Farrell’s Rule #5 reminds us the public buys the most at the top.

None of this argues for selling everything today. Most of the supply lands in 2027, and demand is still strong. However, it changes the math for portfolios crowded into AI. When OpenAI and Anthropic list, managers must sell something to own them. The likeliest “funding source” is the mega-cap AI names already dominating portfolios. Rebalance winners to target weights, skip the day-one IPO chase, and hold cash for unlocked shares at better prices.

The underwriters always get paid. The only question is who’s holding the paper when the lockups expire.

Reader Question: Why Buy MBB?

After our recent article, “Think Rates Are Peaking?” a reader questioned, as quoted below, whether a mortgage-backed securities ETF like MBB makes sense when its dividend yield sits far below today’s 7%-plus mortgage rates. It’s a fair question worth exploring. (Note: the question claims the yield is 3.5%, whereas the 30-day SEC yield is 4.52%)

The problem michael is that if you want to capture the current juicy yield of 7 plus u cannot find that in an etf so there is zero incentive buying an mbs etf that yields 3.5 pc in my book.

The current 7.40% average mortgage rate per Freddie Mac is what homeowners pay, not what investors receive. Servicing and agency guarantee fees take a cut of nearly 0.75% to 1.00%, so new MBS pools pay investors about 6.50% to 6.75%.

Q: Why is MBB’s dividend only about 4.5%?

Most of MBB’s holdings are older mortgages with an average coupon of 3.63%. Its dividend reflects those low coupons.

Q: So should you expect MBB’s return to be near 4.5%?

No. Those low-coupon bonds trade below par; thus, every dollar homeowners prepay or return with repayments comes back at par (100). Thus, with MBS prices in the low 90s, that principal return adds extra return. This explains why MBB’s yield to maturity is 5.87%, per iShares. That return over the dividend yield shows up in the share price, not the dividend.

Bottom line: Judge MBB by its yield to maturity, not its dividend.

Think Rates Are Peaking? Consider Mortgage-Backed Securities

Think interest rates are peaking? If so, agency mortgage-backed securities (MBS) deserve a look. Think rates have further to climb? MBS may still earn a place in your fixed-income allocation, potentially offering more yield than Treasuries and essentially no credit risk.

Here is the twist. In 2022 and 2023, MBS investors learned a painful lesson. As rates surged, homeowners stopped refinancing, and MBS durations rose at the worst possible time. Today, that dynamic has largely run its course. With 30-year mortgage rates at 7.25% and nearly 80% of homeowners holding a rate below 6%, refinancing has all but stopped, leaving MBS durations little room to extend further. The feature that hurt MBS investors in 2022 and 2023 has little room for further harm.

MBS are a unique type of bond because mortgagees can prepay part or all of their mortgage at any time without penalty. Thus, MBS investors, who have essentially lent mortgagees money, are, inherently, short a prepayment option. The prepayment option accounts for much of the extra yield MBS offer over Treasuries, as well as their greater interest rate risk. But when the risks are limited, MBS holders are often in an advantageous position.

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