The September CPI report revealed slightly higher than anticipated inflation, marking the second consecutive month of an upside surprise. This strengthens the belief that another 50bps Federal Reserve (Fed) cut is highly improbable. However, the rise in monthly inflation should not be significant enough to drastically alter the Fed's overall rate trajectory and certainly not concerning enough to deter the Fed from pursuing policy normalization. A series of 25bps cuts over the coming Fed meetings (November and December) remains our base case.
Report details:
- Monthly headline inflation rose 0.2% in September, hotter than expected, bringing the annual rate to 2.4%—from 2.5% prior. Meanwhile, core inflation, which strips out food and energy, also rose more than expected, increasing 0.3% in the month, pushing the annual rate tick up to 3.3%—from 3.2% prior. Somewhat worryingly, the three-month annualized pace of core inflation rose to 3.1% after notching the lowest reading since August 2021.
- Despite a decline in energy prices—particularly gasoline—food prices rose 0.4% in the month, with five of the six major grocery store food group indices notching an increase, contributing about a third of the total rise in total inflation.
- The rise in core inflation was driven primarily by services, particularly shelter costs, which rose 0.2% in the month amid a continued increase in owner-equivalent rent, rising 0.3% in the period. While nevertheless easing compared to last month, shelter has yet to see a sustained deceleration which is helping keep overall inflation sticky. Elsewhere, car insurance and airline fares also contributed to the increase, rising 1.2% and 3.2% in the month, respectively. The former is now up over 16% compared to a year ago as insurance premiums caught up to the rise in car repair costs. As for core goods inflation, its deflationary trend has seemingly stalled, increasing 0.2% in the period, led by apparel, which rose 1.1% in the month.
- The Fed's preferred supercore inflation measure, which excludes shelter from core services and is primarily driven by wage costs, rose 0.4% in the period, a slight increase from its 0.3% pace in the prior month. This leaves the annual supercore figure at a still elevated 4.3% in September.
- Elsewhere, initial jobless claims, released at the same time as CPI, rose to 258,000 for the week ending on October 5. While markets are putting more weight on the claims data, given that it came in higher than expected and to the highest level since August 2023, it'll be important to see how much of the increase is due to Hurricane Helene. The state-by-state jobless claims breakdown, which comes out with a week delay, will confirm whether the increase was largely due to applicants in states who presumably had delays in filing due to hurricane-related disruptions.
Policy outlook
The second consecutive upside inflation surprise serves as a reminder of the risks of being overly complacent about price pressures, especially when the economy is in decent (but not great) shape. While the Fed may be regretting its decision to start its rate-cutting cycle with a 50bps reduction, it’s most likely response to stronger inflation prints and a more robust job market will be to shift back to a 25bps cutting pace, rather than a sudden halt to easing measures.
Moving forward, the inflation data will become increasingly important. If there is a sustained upward trend in inflation prints, it could impact the Fed’s ability to normalize the rate path and have a significant impact on risk markets.
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