Both top-line and core inflation remain hot, sticky and elevated, which implies that the path of monetary policy demands another supersized rate increase of 75 basis points at the Federal Reserve’s November meeting.
The September Consumer Price Index increased by 0.4% on the month and was up by 8.2% on a year-ago basis, according to government data released on Thursday.
Core prices excluding food and gasoline climbed by 0.6% in September and were up by 6.6% from a year ago. Both increases indicate that inflation remains stubborn nine months into the Federal Reserve’s efforts to restore price stability.
More important, housing costs increased by 8% on a year-ago basis, shelter rose by 6.6% and the policy-sensitive owners’ equivalent rent series was up by 6.7%.
Whatever relief in core inflation that is in the pipeline has not shown up in the rents data, which is the primary factor behind rising inflation in the real economy. On a three-month average annualized pace, rent of primary residence surged by 9.9% and owners’ equivalent residences rose by 9.5%, both of which are simply brutal.
Given the real risks that inflation presents to the American real economy, one cannot simply cherry pick their data points to craft a forward-looking monetary policy outlook.
Rather, this is a time of difficult choices, economic pain and higher interest rates, and it will last a longer period than anyone will be comfortable with.
There are signs of improved readings in core inflation in the months ahead. These include:
- Falling shipping costs, which have fallen nearly 75% for the Shanghai to Los Angeles route.
- Inventory liquidation across the retail ecosystem.
- Easing commodity prices in everything but oil.
- A stronger dollar, which is up by more than 10% against a trade-weighted basket of currencies. This strength will dampen inflation on the margin.
Unfortunately, these trends were not evident in September, when core inflation reached its highest reading in more than 40 years, nor will it likely be the case in October.
At this point, those forward-looking indicators are not the type of clear and convincing evidence that central bankers need to alter their rate hikes.
Investors should anticipate that the Fed will raise its policy rate by 75 basis points in November and by 50 basis points in December.
We do not expect a pause in Fed rate hikes until the end of the first quarter, when the federal funds rate will be in a range of between 4.75% and 5% and stand above the core Personal Consumption Expenditures index—an important gauge of inflation for the Fed that currently stands at 4.7%.
Service costs, which reflect the overwhelming portion of the economy, advanced by 0.8% on the month and were up by 7.4% over the past year while services excluding energy increased by 0.8% monthly and by 6.7% annually.
Energy costs on the month declined by 2.1% in September while gasoline prices dropped by 4.9%. It is important to note that the September CPI report captured the recent nadir in oil prices, which have resumed their upward tilt.
That renewed increase will almost certainly cause energy prices to increase in the October report. All should note that the price cap that the United States and its European allies intend to put on exports of Russian oil on Dec. 5 may result in further discord in global energy markets and carries significant risk to the inflation outlook.
Food prices increased by 0.8% on the month and by 11.2% on a year-ago basis, while food and beverages were up by 10.8% from a year ago and by 0.7% in September.
Apparel costs declined by 0.3% on the month and transportation costs declined by 0.6%. The cost of new vehicles increased by 0.7% monthly while used cars and trucks fell by 1.1%. Airline fares increased by 0.8% on the month.
Medical care increased by 0.8% on the month and was up by 6% from a year ago. Recreation costs and education costs both increased by 0.1%. Commodity prices declined by 0.3%.
Despite some evidence of easing in transportation and energy costs, there was no material relief in core inflation, which remains stubborn.
The tone and tenor of the data imply that a much tougher line on inflation than the one the Federal Reserve has already introduced is likely to be required. And that means that the window for a soft landing has narrowed again. A recession will quickly become the baseline scenario next year for firms in the American real economy.