Strong Inflation Report

The September inflation report exceeded the expectations of most economists. However, it may not be strong enough to deter the Federal Reserve from its gradual move towards the sidelines. In the last 2 weeks, the Labor Department released data showing a seasonally adjusted 0.4% increase in overall consumer prices from August, surpassing the median estimate of 0.3% expected by economists. Year-on-year, prices were up by 3.7%.

  • Core prices, which exclude energy and food to provide a better measure of underlying inflation, rose by 0.3%, resulting in a 4.1% increase on an annual basis.
  • Although the monthly core gain was in line with the median estimate, the unrounded figure was 0.32%, surprising many economists who had predicted just 0.2%.

In summary, the inflation report did not align with the expectations of investors who believed the Fed was finished with tightening monetary policy.

The Fed Gets Some Breathing Room

However, the Fed's projections for core inflation, especially, seem to be too high, as they anticipate a 3.7% increase from a year earlier in their preferred measure of core prices from the Commerce Department. Morgan Stanley economists now estimate a 0.27% monthly rise in the Commerce Department's core measure for September. To meet the Fed's projections, core inflation would need to accelerate to a 4.2% annual growth rate in the final three months of the year, up from 2.6% in the preceding three months.

  • Fed officials have also been acknowledging the impact of the sharp increase in long-term interest rates on monetary policy.
  • This recognition provides the Fed with the flexibility to wait and observe how the situation unfolds. The implied odds of a rate increase at the Fed's penultimate policy meeting in November are now below 15%, compared to around 40% a month ago.

The last meeting of the year falls in mid-December, allowing Fed officials to assess how the rise in long-term borrowing costs has affected the economy and potentially giving them little reason to consider raising rates again.

Tone Is Changing

A top Federal Reserve official said it is "undeniable" that the slowdown in US inflation is a trend rather than a momentary blip, despite a recent string of economic data showing persistent pressure on some prices.

  • Speaking to the Financial Times, Austan Goolsbee, president of the Chicago Fed, denied that progress was stalling on getting inflation back to the US central bank’s 2% target. He cautioned against tying forthcoming monetary policy decisions to a narrow set of data.
  • However, we had been "rapidly approaching" a point where the policy debate was shifting away from how high to raise interest rates to how long they need to be maintained at this level, he said. Nothing in the data in the past six weeks had changed that.
  • Since the last meeting in September, at which officials signaled support for one more rate rise this year and half a percentage point fewer cuts in 2024 than previously estimated, US borrowing costs have risen sharply.
  • At one point, the benchmark 10-year Treasury yield was at its highest level since 2007. The rout has eased in recent days as policymakers at the Fed have hinted that tighter financial conditions may offset the need for another rate rise.

Many, including hawkish governor Christopher Waller, have also reiterated that the central bank has the flexibility to maintain a more patient approach to future policy decisions, and can take time to assess incoming data to get a better grasp on the economy’s trajectory. This is something Goolsbee also endorsed.


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