The Consumer Price Index for September provided little in the way of cooling prices, abatement in energy costs or evidence of broader disinflation that would provide cause for the Federal Reserve to rethink the direction of monetary policy.
We think the Fed will adopt one more 25 basis-point increase in its policy rate this year.
Three supply shocks—trade, energy, and artificial intelligence—all are combining to drive inflation higher heading into the final three months of the year.
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Moreover, 60.96% of all prices on a year-ago basis increased by greater than 3% in September, which is indicative of the underlying pace of inflation across the American economy.
More important, September represents the sixth consecutive month of declining real wages that provides a vivid example of the cost-of-living crisis that is affecting most American households.
While higher-income consumers will continue to spend and keep the household consumption data solid, lower-income households cannot sustain spending at recent levels as their inflation-adjusted incomes decline.
With rising energy prices, transportation costs and consumer electronics combining to drive the CPI 0.6% higher on the month and 3.7% compared to a year ago, it is clear that the central bank will need to move to restore price stability.
What is interesting is that the primary drivers of inflation are supply-side policies that are better addressed by the fiscal authority. But such action will not happen anytime soon, which leaves the Fed to address a re-establishment of price stability amid core CPI advancing at a 0.3% pace on the month and 2.6% from a year ago.
Policy implications
The top-line inflation figure implies that real wages, after accounting for inflation, declined for the sixth consecutive month, which is intensifying the genuine cost of living crisis that many American households are experiencing.
This is why the Federal Reserve will need to raise its policy rate from a range between 3.75% to 4% to one between 4% to 4.25% with risk of further additional hikes should the cause of current inflation dynamics not abate.
The problem is not necessarily an accelerated broadening out of inflation, although one can observe that inside the September data.
The problem is stubborn and sticky inflation that will not decline below 3% in the top-line CPI, PCE or, more important, core PCE anytime soon. That stickiness will demand a higher policy rate unless oil, energy, gasoline and diesel prices are rapidly reversed.
While the Fed could very well hike rates at its Oct. 28 meeting, it will in all likelihood wait until December to make that policy change to avoid an increase so close to the midterm elections.
We expect to see a 25 basis-point hike to close out the year.
The data
Inflation increased by 0.3% ex-food, ex-energy and ex-food, energy and shelter in September, which is evidence of the stubborn and sticky inflation in the American economy.
Energy prices did the most damage. Energy costs increased by 5.2% on the month and by 20.4% from one year ago. Energy commodities were up by 9.3% and 35.3% over that same period while gasoline prices advanced by 9.1% and 34.2%.
Fuel oil costs advanced by 15.3% and by 74.2% from a year ago. Energy services advanced by 0.1% and by 4.6%; electricity by 0.2% and 4.4%; and utility gas services declined by 0.3% and by 5%.
Service prices, which best capture the internal dynamics of Americans economy, climbed by 0.4% in September and by 3.2% annually, while services excluding energy also climbed 0.4% and 3.1%.
If one is looking for evidence of an AI-caused inflation, look at computer peripherals, which increased by 1.3% in September and by 9.2% from one year ago.
Food prices were flat on the month and rose by 2.5% from one year ago.
Housing and shelter costs increased by 0.4% in the month and by 3.3% and 3.2%, respectively, over the past year. The policy-sensitive owner’s equivalent rent advanced by 0.3% monthly and by 3.3% from one year ago.
Transportation costs increased by 2.5% on the month and by 7.9% over the past year. New vehicle prices increased by 0.2% monthly; used cars and trucks jumped by 0.7%.
Delivery services were up by 17.3% from a year ago. Air fares climbed by 1.2% in September and by 22.4% annually. Apparel prices rose by 0.3% and by 3.4% from a year ago. Medical care increased by 0.1% and by 1.5%.
The takeaway
Evidence of policy choices over the past two years was on display as headline inflation climbed 3.7% from one year ago primarily because of energy costs, tariffs and demand linked to the buildout of artificial intelligence infrastructure.
There is little evidence of a cooling or a broad-based disinflationary impulse: 60.96%, of all prices increased at greater than a 3% pace in September, which captures the underlying pace of inflation.
In addition, on a three-month annualized basis, inflation is rising at a 4.6% rate, suggesting that action by the Fed is warranted.
The net effect is that real wages have declined for the past sixth months, which will result in a drawing down of national savings and tapping of credit by middle class, working class and poor households.
While upper-end households will continue to spend, keeping the economy growing at a strong pace, one should anticipate that the discontent across all other households will not abate anytime soon.
We expect that because of the proximity of the midterm election, the Fed will remain on hold at its Oct. 28 policy meeting and then lift the policy rate by 25 basis points at its December meeting.
