Takeaway: A higher-than-expected inflation report has markets anticipating a Fed rate hike next Wednesday, but there’s more room than usual for markets to be surprised.
Overall and core inflation both came in somewhat high with no obvious statistical distortions.
- Overall CPI inflation was 0.4% month-over-month (3.4% annually), largely driven by higher gas prices. Setting aside the food and energy categories, core inflation, which the Fed anchors its inflation goals to, was up 0.3% month-over-month (2.4% annually).
- Because this print is seen as so pivotal to the Fed rate hike decision next week, it’s important to look at more digits to the right of the decimal place. The key 0.3% monthly core inflation number was 0.29% vs. 0.22% expected by forecasters, meaning this was high, but not a blowout.
- Within core inflation, the largest category, shelter inflation, came in at 0.3% month-over-month after two months of 0.1% growth. The key driver was not rent, however. It was a bounceback in hotel prices that had seen large declines in June and July.
- The inflationary pressure was not all isolated to a couple of categories, however. Eating out, transportation, and new and used vehicles all had significant increases.
- The Fed officially anchors their inflation target to core PCE inflation, not CPI. But the two measures share many of the same input data points. Between today’s CPI data and yesterday’s PPI data, this month’s core PCE read will be above the threshold seen as needed to get the Fed to hike next week
The Fed will most likely hike on Wednesday but there is lingering uncertainty. And the effect of a hike on long term rates, like mortgage rates, is difficult to predict.
- With three dissenters at the last meeting who supported hiking and Warsh’s own hawkish Jackson Hole remarks, the rapid rise in oil prices these past two weeks and today’s inflation data will probably get enough people over the line for the hike to materialize.
- However, under the new Chairman, the Fed’s framework and reaction function have become much more uncertain. Also, some could argue that the rapid rise in long term rates these past two weeks have moved rates into more restrictive territory and there’s less need for a formal hike. And the economic case for needing a hike is simply not a clear cut as it was when the Fed was hiking in 2022 because inflation is only marginally above target (though stubborn) and it’s not absolutely clear that monetary policy action is needed to bring it back to target.
- So even if the official vote is nearly unanimous for a hike next week, in reality, the committee is probably more evenly divided.
- And given the volatility in rates recently along with all of the geopolitical and economic factors at play right now, long term rates may not increase with a hike. It will partly depend on how Chairman Warsh talks about upcoming meetings and the Fed’s own forecast for the rest of the year, but it’ll also depend on how markets view the Fed’s long term credibility in taming inflation.
