September CPI tops forecasts on higher energy costs
The consumer price index rose by 0.4% in September, coming in modestly hotter than the consensus forecast of 0.3%. Core inflation, which excludes more volatile food and energy prices, rose by a slightly more muted 0.3% for the month, in line with expectations.
A surge in energy prices was the primary catalyst for a greater-than-anticipated uptick in the monthly CPI, with much of that directly attributable to gasoline prices. Given the continued conflict in the Middle East, upward pressure on oil prices could persist in the near term, lifting near-term CPI forecasts. Thus far, the reaction has been comparatively limited, perhaps on hopes that neighboring countries or groups won’t be drawn directly into the conflict.
Although the signs of the gradual easing trend in prices remain intact, the cautionary note on inflation comes in the trailing 12-month CPI, which has found a near-term floor in recent months. That measure held steady at 3.7% in September having bottomed at 3.0% in June.
The story on core inflation – arguably the more important gauge of the underlying direction of prices over time – eased modestly to 4.1%. Once the impact of recent energy price volatility is stripped out, inflation still appears to be gradually receding, but at a pace that could frustrate both consumers and policymakers. A return to the Fed’s 2% target still appears to be further on the horizon than most would prefer, although a more pronounced slowdown in the economy could change that picture quickly.
How the Fed will read this remains to be seen. Coming on the heels of last week’s surprisingly robust employment data, inflation data that remains above a comfortably sustainable pace could make the case for some Fed policymakers that more needs to be done to bring the economy back into balance. The probability of another rate hike was put squarely on the table by the FOMC in September. Markets responded in kind, sending a signal that there was a growing recognition that the Fed was serious in its “higher-for-longer” forward guidance.
Since then, the surge in long-term bond yields and tightening in financial conditions may have done as much or more to rein in the Fed’s perceived need to do more as another rate hike would, despite the spate of stronger-than-expected economic data in the past week. Recent comments from multiple Fed governors would seem to reinforce that view, a notable shift in tone since mid-September.
In response, Fed funds futures have reversed sharply in the past several weeks, now pricing in a less than 10% probability that the Fed takes a quarter point in November. Notwithstanding the Fed’s September forecast to the contrary, the futures market is also now marginally betting against a rate hike in December.
Despite indications of solid economic momentum, multiple near-term risks could present challenges. The immediate risk of a federal government shutdown was narrowly avoided, but the solution was a temporary patch that just deferred more difficult budget finagling to closer to year end. The UAW strike shows little sign of being easily resolved, with yesterday’s announcement of an expansion of striking workers ratcheting up the stakes. Rising geopolitical risk creates additional uncertainty that could push energy prices higher and weigh on sentiment. Consumers are feeling the pinch of the resumption of student loan payments, rising gas prices, and higher interest rates. The collective weight of these factors has the potential to push back meaningfully against growth momentum in the coming months.
The bottom line? The tug of war between recent inflation, jobs data, and tighter financial conditions have put the spotlight on the Fed’s November 1 policy decision. A month ago, another quarter-point rate hike looked like a lock before year-end. Today, that’s less clear, despite indications that the economy may not yet be ready to surrender to the collective weight of the Fed’s cumulative efforts to date.
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