3 things to know as the ASX 200 rallies to a five month high

US markets surged on Thursday after a cooler-than-expected inflation report revived hopes of a downshift in Fed rate hikes and a peak in pricing pressures.

Here are three things investors should take note of as the ASX 200 rallies to a five month high.

1. Fed pivot is back

The Fed crushed the idea of a pivot last Wednesday, with Powell saying he would rather run the risk of over-tightening than not tighten enough and let inflation become entrenched.

The S&P 500 tumbled -2.5% on that day, as Powell reiterated "we have some ways to go" and that the terminal rate may be higher than previously expected.

After last night's inflation print, that view is just an afterthought.

Current market expectations for the Fed Funds rate:

• Dec 2022: 50 bps hike to 4.25% - 4.50%

• Feb 2023: 25 bps hike to 4.50% - 4.75%

• Mar 2023: 25 bp hike to 4.75% - 5.00%

• Pause till Oct 2023

• Rate cuts to start coming through in November 2023 onwards

The likelihood of a 75 bp rate hike in the December meeting evaporated after the CPI print. There's now a 83.0% probability that the Fed will hike rates by 50 bps, up from 56.8% a day ago.

Source: CME Group

2. Dollar decline inspires resources rally

The already top-heavy US dollar slumped even more overnight on expectations of a less aggressive Fed.

This helped commodity-related stocks surge. US-listed BHP and Rio Tinto closed the session 4-5% higher. An easing US dollar is typically a tailwind for commodity markets, as prices become cheaper for non-dollar currencies.

Several US-listed commodity ETFs surged overnight, including:

• VanEck Gold Miners +7.5%

• Global X Copper Miners +6.78%

• VanEck Rare Earth/Strategic Metals +6.71%

• Global X Uranium +5.41%

What's interesting is that while commodity stocks surged, commodity prices aren't rallying as much in comparison. Its likely that the spike in covid cases in China and rising lockdown risks is keeping prices at bay.

Still, the Bloomberg Commodity Index (blue) and US Dollar Index (orange) are at a key inflection point.

Source: TradingView

3. Yields topple

Bond yields slumped to reflect a more dovish outlook for US interest rates. This has also been reflected in the Australian Government 2-year bond yield, which typically reflects short-term interest rate expectations.

Source: TradingView

This has supported yield sensitive sectors such as tech and real estate, two sectors that led to the upside on both Wall Street and the ASX.