BMO's Davis: Upcoming CPI Data Could Give Fed Cover to Pause Rate Hikes

The Quick Take

• BMO's Earl Davis says Friday's US CPI report could provide the Fed an 'easy out' to avoid hiking rates
• Davis is monitoring mortgage convexity sellers as a secondary indicator of rates market stress
• If CPI prints below expectations, it may reduce pressure on the FOMC to act at its next meeting

BMO Global Asset Management's head of fixed income Earl Davis offered a nuanced take on the Federal Reserve's next move, suggesting the upcoming US CPI data carries the potential to hand policymakers a politically comfortable exit from the rate-hike debate. Davis's view is notable against a backdrop where the US labor market has proven unexpectedly robust — strong payrolls data prompted UBS and other banks to revise rate forecasts upward — yet inflation data has shown pockets of softness that could give the Fed a data-dependent reason to hold steady. His framing positions CPI as the tie-breaker in an unusually balanced Fed debate.

If CPI underperforms expectations, the implications cascade: Treasury yields would likely decline, supporting longer-duration bonds and compressing mortgage rates modestly. Davis's watch on mortgage convexity sellers is instructive — these investors hold mortgage-backed securities and are forced to sell duration when rates rise because prepayments slow and duration extends. A CPI-driven pause scenario reverses this mechanical selling pressure, potentially fueling a bond market rally. Rate-sensitive equity sectors — real estate, utilities, and growth tech — would benefit from reduced discount rates. A hot CPI print that forces a hike would sharply reprice these sectors lower.

The Friday CPI release is the single most important near-term datapoint for global markets heading into what traders price as a live Fed meeting. Beyond Friday, the Fed's dot-plot projections and September FOMC statement are the definitive signals for the rate path. The macro variable that determines whether Davis's 'easy out' thesis plays out is the shelter and housing component of CPI, the stickiest contributor to above-target readings. A moderation in housing costs would be the cleanest path to a durable Fed pause — absent that, even a headline CPI miss may prove temporary and insufficient to shift the Fed's trajectory.

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