The September CPI report delivered everything the Federal Reserve did not want to see. Both headline and core CPI came in hotter than expected, with core CPI even hitting a new 40-year high of 6.6% year-over-year. The composition of the inflation reading showed shelter and medical services, two very sticky components of inflation, continuing to drive price pressures. The inflation report adds to our conviction that inflation will decline at a painfully slow pace and will require further significant Fed tightening. A fourth consecutive 75bps hike at the FOMC meeting in November is all but guaranteed, and a fifth at the December meeting now needs to be considered.

Consumer Price Index (CPI) inflation
Year-over-year, 1960–present

Graph of CPI inflation, year over year, from 1960 to 2022.

Bureau of Labor Statistics, Principal Asset Management. Data as of October 13, 2022.

Report details:

  • Headline CPI rose 0.4% month-on-month (expected +0.2%), bringing the annual rate only down to 8.2% (expected 8.1%)—just a 0.1% drop from August’s 8.3% YoY reading. Core CPI rose 0.6% (expected +0.4%), pushing the annual rate up from 6.3% to a 40-year high of 6.6% (expected 6.5%).
  • The rise in monthly inflation was once again very broad-based, with strong gains from core services in particular. Shelter price inflation rose 0.7% on the month, the same pace as in August and showing no sign of slowdown. Worth a third of the headline CPI index and about 40% of core CPI, shelter is proving itself a very sticky and lagging component. As home price growth is still strong (and flows to the shelter component act with a long lag), relief in rent inflation could still be some way off.
  • Medical services were also a significant contributor to the September CPI, rising 1.0% month-on-month and 6.5% year-on-year. Unfortunately, Fed policy can only have minimal impact on this part of the CPI basket.
  • Gasoline prices fell 4.9% month-on-month in September, but natural gas prices accelerated. Food inflation rose 0.8% in September, the same as in August, suggesting that grocery bills must be straining household budgets. Food, shelter and medical services were the largest contributors to the September CPI increase.
  • Within core CPI, a month-over-month decline in used car prices and apparel provided a small bright spot. However, this was offset by a sharp increase in new cars and household furnishings.

Sticky and flexible core CPI
Year-over-year, 2010–present

Chart of sticky and flexible core CPI, year-over-year, from 2010 to 2022, showing flexible core CPI spiking up to 20% in 2021 and 2022.

Federal Reserve Bank of Atlanta, Principal Asset Management. Flexible prices move more quickly and frequently, while sticky prices are less responsive but more persistent. Data as of October 13, 2022.

Implications for Fed policy

The September inflation number is deeply concerning and suggests that the inflation fight will be protracted and painful. Indeed, after 325bps of tightening from the Fed, core CPI is still increasing! It is abundantly clear that the Fed has a lot more work to do, and a 75bps hike in November will need to be followed up with further aggressive hikes in the following months. A fifth consecutive 0.75% increase in December would blow through the Fed’s projection for a peak Fed funds rate of 4.6%. Market expectations for Fed rates have unsurprisingly moved higher, and are now pricing in a peak of around 4.9%.

Equity markets have been hammered in recent weeks, and the latest inflation data means there is no let-up in sight. With inflation persisting at levels far above the Fed’s comfort zone, and peak hawkishness being postponed amid broadening core inflation, investors hopeful for an imminent risk asset rebound will likely be disappointed.


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