Local stocks and the Aussie Dollar fell and shorter dated bonds rallied today. The big picture that has been driving prices since the end of August saw several adjustments. Coming days will reveal whether this shift is an enduring one or a short term adjustment.

The ASX200 lacked initiative today and finished the session close to its worst levels of the day. The primary weakness was the resource sector. The last day and a half has seen the US dollar index steadily recover putting downward pressure on commodity prices. The US dollar trade has become a one sided affair of late and the current bout of short covering represents the main risk for markets as they wait for news from the Federal Reserve at next week's policy meeting. The FOMC may not want to actively lower rates by undertaking QE - but they may not be faced with that question. The current market is so fully priced for QE that the main resolution for the FOMC will be to choose between a small QE and no change in rates on one hand, or no QE and a significant sell-off on the other. Equities also look fully priced for QE.

The main reason the market didn't fall further was due to the relative strength of the financials after the NAB reported a better than expected full year profit result. Since the end of August, financials have underperformed the market amidst soft readings on credit growth locally and the global preference for commodities as central banks devalue their currencies through QE. Tomorrow sees the ANZ report results, followed by Macquarie Group on Friday. Better numbers could see improved sentiment towards the sector as money exits resources in the short term.

The Marquee event of the week was the release of September quarter inflation numbers. Both the headline and underlying CPI measures undershot market expectations, but underlying inflation remains close to the RBA's central forecast of 2.5%pa. The data has driven a re-pricing of near term RBA rate expectations. Headline CPI rose 0.7% in the September quarter to be 2.8% higher over the last year. The trimmed mean measure, the RBA's preferred measure, rose 0.6% in Q3 or 2.5% over the last 12 months. Market expectations were centred on an increase of 0.8% Q/Q (2.9% Y/Y) for the headline figure and 0.7% Q/Q for the RBA's two preferred underlying measures (2.6% Y/Y).

In the October minutes, the RBA stated they expect underlying inflation of around 2.5-2.75% per annum in Q3. That has now slipped to 2.5% or a little less, so the forecasts are going to require some re-jigging.
Market pricing has not unreasonably shifted the odds of a 25bp November increase to just 16%, from near 50% yesterday. Interest rate futures are now implying just one 25bp hike by April next year.

Today's lower outcome will make it difficult for the RBA to justify a November rate rise. The RBA made it clear in their latest meeting minutes that a case can be made to raise rates based on the medium term inflation outlook. If the RBA decides to remain on hold in both November and December, they will have to wait until February before making another decision. This delay could raise the risk of being behind the game on inflation in 2011. Therefore a December move cannot be ruled out.