The Inflation Story is Not Over

This is the last CPI before the Fed’s next FOMC meeting and rate decision on November 1, 2023. Given that the Fed has become highly data dependent, this was an important data release for the markets.

As I posted in the Breakfast Bites this morning, most banks were forecasting a softer number and while they came in correct on the Core CPI numbers, the headline number came in hotter.

The final result:

Clearly the MoM headline numbers came in hotter than the consensus leading the yearly numbers higher. We now have a situation where the market can confirm that inflation is reaccelerating. While the Fed has been concentrating on bringing down core inflation, food and energy costs have been going up. Their view has been that these items are volatile and to a large extent out of the Fed’s control.

While true, it doesn’t mean that they can’t do anything about it. Raising rates and tightening financial conditions is meant to destroy overall demand leading to a shift downwards in inflation, higher unemployment, and lower economic growth, even in the face of exogenous factors.

Does it matter where the inflation comes from when it goes up? For macro people like us, yes we like to see the details that will tell us whether this trend will continue. But at the end of the day, food and energy costs increasing is what hurts everyone. So that’s definitely what the Fed ought to be concerned about and what we all ought to be concerned about.

The Market Reaction and the Fed

To be fair, the miss was minor. However, the market’s strong negative reaction is because this could push up the probability of inflation remaining stubborn.

And we all know what that means. You guessed it. “Higher for longer!” With inflation remaining stubborn the Fed will not only likely hike in November but keep rates higher next year. They already lowered their projections for a rate cut, i.e., only 0.50% will be cut vs. the market’s previous forecast of 1%. While the probability of a November hike still remains low, this may adjust in the next 20 days prior to the meeting.

Visually, it would seem like we are forming a new trend higher in Headline inflation while Core seems to be coming under control. But, a look under the surface tells us that there a few concerns.

Here’s the full CPI heatmap that I color code from the data pulled from bls.gov to tell us clearly what is accelerating and what’s not.

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