The disinflationary trend that has worked its way through the economy for much of the year modestly abated in October as the top-line consumer price index increased by 0.2% and the core rose by 0.3% on a monthly basis.
While a portion of the increase can be attributed to one-time factors, the sticky nature of service and shelter inflation will continue to support inflation near 2.5% for now.
On an annual basis, those figures increased by 2.6% and 3.3%, respectively.
The primary catalysts were, as expected, a large 2.7% increase in the cost of used autos—a hurricane-induced destruction of property typically results in a price jump in this category—a 3.2% increase in airline fares and sustained stickiness in housing and service inflation.
While a portion of the overall increase can be attributed to one-time factors, the sticky nature of service and shelter inflation will continue to support inflation near 2.5% for now.
In addition, with government spending likely to expand next year, the interplay among inflation, expectations and policy is sure to be a primary focus of investors, firm managers and policymakers.
Policy implications
With a fresh round of tariffs on the way, coupled with an economic populism that favors unfunded government spending and tax cuts, investors are pricing in a far less sanguine inflation outlook than they did just two months ago.
The return of a positive term premium to Treasury issuance and the prospect of inflationary fiscal policies are pushing rates along the maturity spectrum higher.
In addition, market-based inflation expectations like the Federal Reserve’s five-year, five-year forward breakeven rate have risen to 2.36% from 2.08% just 60 days ago.
Read more of RSM’s insights into the economy and the middle market.
The Fed will continue to move toward another 25 basis-point reduction in its federal funds policy rate at its meeting on Dec. 18, which would take the rate to a range between 4.25% and 4.5%.
Before then, though, there will be plenty of hard data, including the personal consumption expenditures price index, which is the Fed’s preferred gauge of inflation, as well as the November consumer price index . The Fed will have time to shape expectations around any rate cut or pause.
But given the robust economic expansion in addition to the arrival of expansionary fiscal policy, the Fed may find itself needing to pause at one point next year.
This prospect poses a risk to our forecast of four 25 basis-point cuts next year—one in each quarter. Instead, the Fed may opt for a slightly shallower path of rate cuts.
The data
Inflation increased in October on the back of a 0.4% increase in housing and service costs, which are proving quite sticky even as the overall disinflationary trend remains intact.
Apparel costs declined by 1.5%, and new vehicle costs were flat as energy costs were unchanged. Gasoline prices fell by 0.9% on the month. Perhaps more encouraging was the fact that motor vehicle insurance costs, which have increased by 14% over the past year, declined by 0.1% in October.
Because the October sampling period ended in the middle of the month, the notable decline in oil and gasoline prices in the November sampling period will put downward pressure in the next CPI report and revive the disinflationary trend that has characterized much of the year.
Food and beverage costs increased by 0.2% on the month and transportation costs increased by 0.3%. The costs of recreation increased by 0.4%, while education and communications costs declined by 0.3%. Commodity prices were flat on the month.
The takeaway
One-time special factors and ongoing sticky shelter and service prices combined to cause an increase of 2.6% in the consumer price index in October with the core excluding food and energy increasing by 3.3%.
Because of falling oil and energy prices, we expect the modest disinflationary trend that has characterized much of this past year to reassert itself inside the next CPI report.
But investors are now focused on the expansionary fiscal policy that will arrive next year. One should anticipate that the term premium, yields and inflation expectations will creep higher as risks of rising inflation proliferate.
Elections have consequences, and the immediate consensus is that the economy, which is already strong, may accelerate amid higher import taxes and inflation.
