Monetary Policy & Inflation | US
Hot Inflation Supports a Hawkish Fed
- By Dominique Dwor-Frecaut
- 5 min read
Summary
- September CPI was higher than expected, and I have revised my end-2022 core inflation scenario to 6% YoY.
- Stable core goods price inflation largely reflected more expensive new cars and trucks.
- Higher core services inflation largely reflected higher OER, which is likely to keep increasing at a sustained pace for some time.
Market Implications
- I continue to expect 75bp hikes in November and December.
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Summary
- September CPI was higher than expected, and I have revised my end-2022 core inflation scenario to 6% YoY.
- Stable core goods price inflation largely reflected more expensive new cars and trucks.
- Higher core services inflation largely reflected higher OER, which is likely to keep increasing at a sustained pace for some time.
Market Implications
- I continue to expect 75bp hikes in November and December.
Inflation Continues to Accelerate
US inflation is still here, and still too hot for the Fed’s liking. Coming in yesterday at 6.6% YoY, core inflation broke a 40-year high and sent markets spiralling. The S&P 500 dipped below 3,500 initially before a remarkable reversal saw it end the day up 2.6%.
Yet although markets may be spinning, the data only clarifies the path for the Fed at the upcoming meeting on 2 November. I expect 75bp there, and another equally sized hike in December. First, though, let’s dig into the details.
The Print
September CPI was higher than expected at 0.4% for headline and 0.6% for core MoM, against 0.2% and 0.4% expected and 0.1% and 0.6% in August. Also, median price inflation MoM remained high at 67bp against 74bp in August.
On a six-month annualized basis, which is less noisy than MoM or 3m while still capturing short-term changes, core inflation accelerated further (Chart 1).
I did not expect this surprise – the monthly data is volatile. But I expected CPI prints to continue to align with my overall macro view: the stabilization of core goods inflation (on persistent supply bottlenecks) and accelerating services inflation (from the tight labour market). This is largely what happened in September – and August.
Goods Price Inflation Stabilizes
The most important drivers of September core goods inflation were new cars and light trucks, which increased by 70bp MoM. Used car and truck prices fell by 1.1% MoM. But since Americans spend five times more on new than used cars, it failed to lower core goods inflation (Chart 2).
Hot Labour Market Raising Services Prices
The most important driver of September core services inflation was shelter again. Owners’ equivalent rent (OER) was behind this: it increased by 0.8% following a 0.7% increase in August. Shelter represents almost 60% of core services weights. In September, shelter contributed 46bp to core services inflation of 79bp MoM.
House price inflation finally turned negative MoM in July. But this will translate slowly to shelter cost inflation. Meanwhile, wages are likely to remain the dominant drivers of rents.
As of 13 October, the Atlanta Fed median wage estimate for September has not been published. However, with the NFP showing still a very tight labour market, I expect it will be near or above 6.7%.
The labour market remains tight until the Fed hikes enough to slow the economy. And as long as it does, wage growth and services inflation will likely keep trending higher (Chart 3).
Market Consequences
Following the CPI print, markets are pricing a 75bp hike in November and almost 75bp in December.
I continue to expect 75bp at both meetings. The Fed’s current internal debate is between a 75bp and 50bp clip. The doves argue 75bp risks overtightening, while the hawks see a 50bp clip pushing the Fed further behind the curve. For November, the doves have already accepted 75bp, based on their agreement to react to actual rather than expected inflation.
Today’s data bolsters the hawks’ case, especially since too few data points are due between the November and December FOMC meetings (one NFP and two CPIs) to fundamentally change the macro picture. The economy moves far slower than markets, and the Fed is focused on the economy more than on markets.
Dominique Dwor-Frecaut is a macro strategist based in Southern California. She has worked on EM and DMs at hedge funds, on the sell side, the NY Fed , the IMF and the World Bank. She publishes the blog Macro Sis that discusses the drivers of macro returns.
(The commentary contained in the above article does not constitute an offer or a solicitation, or a recommendation to implement or liquidate an investment or to carry out any other transaction. It should not be used as a basis for any investment decision or other decision. Any investment decision should be based on appropriate professional advice specific to your needs.)