Odds of an October Fed Hike Fall to About 17% After Hot Inflation as AI Selloff Pulls Dollar Lower

The hot inflation print that sent gold tumbling earlier this week has not produced the rate-hike panic traders priced in on Wednesday. By Friday, Oct. 16, the CME FedWatch Tool put the odds of the Federal Reserve holding rates steady later this month at 83%, up from 49% a month earlier. The dollar was on track for its first weekly fall against the euro and the yen in more than a month.

The data was not soft. Consumer prices rose 0.6% in September, taking the annual rate to 3.7%. Producer prices posted their sharpest monthly gain since 2022, and core producer inflation, which strips out food and energy, rose 0.7%, above estimates. Retail sales also beat expectations, helped by higher receipts at gas stations.

Fed officials pour cold water

What changed the mood was the Fed itself. Comments from Fed officials signaling no urgency to tighten further helped stabilize Treasury yields and eroded support for the dollar. The 10-year yield slid below 5.1% on Thursday.

Chair Kevin Warsh added no clarity at the IMF and World Bank annual meetings in Bangkok on Friday. He said he does not "prejudge meetings."

John Velis, Americas macro strategist at BNY, said he does not see enough committee support, particularly among governors, for an October hike. "It still leaves December an unanswered question and there is a lot to happen between now and then," Velis said.

The AI trade takes the wheel

Wednesday's inflation report hit stocks hard. The S&P 500 fell 1.11% and the Nasdaq Composite fell 1.88%, each its worst day since July. A benchmark semiconductor index dropped 4.3%. Oracle fell 8.8%, Marvell 8.7% and Dell 11.3%.

The pressure continued Thursday. The PHLX Semiconductor Index fell about 2% on Oct. 15 and is down almost 10% over the past week, though it is still up 61% this year. South Korea's KOSPI, heavily exposed to memory chips, plunged almost 8% on Thursday and has dropped 18% in five sessions.

Money rotated rather than disappeared. The Dow gained more than 400 points on Thursday, or nearly 0.9%, on gains in Nike, UnitedHealth, Sherwin-Williams and Walmart. The S&P 500 ended higher Thursday after early losses.

CNN cited two forces behind the tech pain. Higher yields and sticky inflation have raised borrowing costs for the data center buildout. Chinese chipmaker CXMT also announced progress on advanced memory chips, which raised competition concerns for U.S. and South Korean producers.

The stress has reached credit. Investors crowded into bets along the AI supply chain are worried that data center operators may not turn profitable in time to service their debts.

A dollar that stopped acting like one

A tech selloff normally sends money into the dollar. This week it did not. Matt Weller, global head of market research at StoneX, said the greenback "is actually falling" even as some safe-haven buying showed up in bonds.

The dollar index fell 0.17% Friday to 101.87 and was set for a 0.35% weekly drop. Sterling rose to $1.3314. The Swiss franc gained more than 1.4% over two sessions, and the euro was near $1.1227.

Thierry Wizman, global forex and rates strategist at Macquarie Group, said Wednesday's moves showed what could pull yields lower in coming months and in 2027: a reduction in the outlook for AI investment. His reasoning is that it would shrink bond supply and impair U.S. growth.

Not everyone sees a dollar breakdown. Chris Turner, forex strategist at ING, said that barring another big leg down in AI stocks and risk assets, he expects the dollar to consolidate near recent highs. "It is only when short-end rates break lower that the dollar is ready to drop. And we are not there yet," Turner said.

Gold, oil and the inflation source

Gold was quoted near $4,165 an ounce on a trading platform late in the week, back above the $4,100 level it broke on Oct. 14, as falling October hike odds eased pressure on bullion.

The inflation driver has not gone away. Brent was quoted near $107.75 and WTI near $99 on the same platform, both higher on the day, with gasoline above $4 a gallon behind the September CPI jump. Investors also expect President Donald Trump to avoid escalation in the Middle East or Ukraine, since a wider conflict could fuel inflation and hurt his standing before the midterm elections.

What the AI sell-off does and does not show

Susanto of Gabelli Funds argued the problem is not the fundamentals. "The biggest challenge in AI investing right now isn't the fundamentals," he said. "It is the expectations that are fragile." He expects the infrastructure buildout to continue into the new year, with suppliers expanding capacity.

LPL Financial's Adam Turnquist made a similar point about Asia. He said enthusiasm for the broader AI investment cycle remains intact, but Korea's concentrated exposure to memory leaves it more exposed to competitive threats and shifts in the memory cycle.

The Fed's decision later this month is the next test of the market's reading. A 3.7% inflation rate, a Fed chair who refuses to give guidance, and an equity market leaning on a debt-fueled AI buildout all point toward December. Warsh has not said whether he thinks the committee will act then.