Takeaway: A higher-than-expected inflation report puts the odds of a rate hike in two weeks at 50/50. Rates will give back some of last week’s improvements.
Both overall and core inflation–which excludes food and energy prices–jumped in September more than expected.
- Overall inflation for September came in at 0.65% monthly (vs. 0.58% expected and 0.40% previously), driven by big increases in gas and diesel prices. With overall inflation at 3.7% annually, wages, at 3.0%, are not keeping up.
- The problem is broader than energy prices alone. Core inflation came in at 0.34% (vs. 0.22% expected and 0.29% previously), largely because of higher-than-expected inflation in owners’ equivalent rent, hotels, and wireless. Only time will tell whether these increases turn out to be blips, but no obvious statistical distortions are driving the narrative today. Owners’ equivalent rent, which is how much homeowners (who mostly have a constant mortgage payment) would need to pay to rent their house, is a very important but complex category to measure. Notably, there is little in market rent data, recently or over the last few years, to worry about from an inflation perspective.
- Core PCE, the measure of inflation the Fed uses as its gauge, for October won’t be released until the day after the Fed’s October 28th meeting. However, Fed officials will go in with very accurate estimates based on today’s CPI data and tomorrow’s PPI data. With just today’s data, core PCE estimates range between 0.31% and 0.38% monthly. After tomorrow, if the estimate lands on a number that rounds to 0.4%, the Fed may find it difficult not to hike at the October meeting.
Today’s data puts the Fed in a potentially uncomfortable spot. The October hike will be a close call.
- Fed officials have been unanimous in recent public engagements that, though they see more hikes down the road, they are not in a hurry to hike at consecutive meetings. That message, likely aimed at rapidly rising mortgage rates, helped bring rates down modestly last week as traders penciled in a pause at the October meeting.
- The Fed may find itself caught between a rock and a hard place. If it doesn’t hike and core PCE for October lands at 0.4%, long-term rates may jump again as the market questions the Fed’s credibility on fighting inflation.
