Another month, another firm U.S. CPI report: The core CPI (Consumer Price Index) in September once again came in stronger than consensus expectations across consumer spending categories that tend to be “stickier,” including shelter and healthcare. This is bad news for Federal Reserve officials, who are trying to re-establish price stability, and for U.S. consumers, who are already facing a decline in their real wages. Core CPI rose to a new peak of 6.6% year-over-year (y/y), while headline CPI ticked down to 8.2% y/y.
The September report reaffirms our view that inflation will likely remain “sticky” at an elevated level over our cyclical horizon, although easing energy and food commodity prices should continue to moderate headline inflation (see our latest Cyclical Outlook). September’s report also likely bolsters the Fed’s resolve to fight inflation through stronger actions aimed at tightening financial conditions. We see 75-basis-point (bp) rate hikes as now likely in both November and December, while the steeper monetary policy path points to downside risks for our already contractionary U.S. GDP outlook.
Inflation report details: rent, retail, medical services, cars
The primary driver of inflation again in September was shelter. Rents and owners’ equivalent rents (OER) jumped 0.8% month-over-month (m/m), up from already hot readings of 0.7% m/m in August. Rent increases were particularly notable in large cities, a change from earlier in the pandemic when rents outside of major cities were significantly stronger. Counterintuitively, interest rate hikes are likely contributing to faster rental inflation, as they make owning a home less affordable. Historically, it’s not until housing price inflation starts to moderate more materially and the labor market softens that rental inflation also starts to slow (reported CPI inflation has tended to lag broader housing market trends by three to six quarters). These factors underscore the challenge facing Fed officials as they try to bring inflation back toward target. We think that shelter prices – which account for about one-third of the CPI basket – are likely to peak above 8% on a y/y basis versus the pre-pandemic trend of about 3.5%, before eventually moderating as a result of higher interest rates and rising unemployment.
Goods price inflation offered better news than shelter, but remained stubbornly firm. Core goods (excluding used auto prices) were up 0.3% m/m – less than the 0.6% m/m pace seen in August. But surging inventory/sales ratios, cooling demand for retail goods, and heightened reported discounting from corporate officials during earnings calls have not filtered through to consumer prices as much as previously hoped.
Medical services prices surged (+1% m/m) in September, which is the last month before the BLS (Bureau of Labor Statistics, which publishes the CPI) incorporates new annual data that we believe should support a somewhat more modest overall core CPI print starting next month. The BLS uses a retained earnings methodology relying on data that is only published once per year and with a lag. CPI has been benefitting from strength in health insurance margins due to the relative lack of medical procedures in 2020 during the pandemic, but this will fall out starting with the next report.
Used car prices fell (−1% m/m), and new car prices rose in line with recent trends as inventory levels remain far below normal. While there has been a notable recent decline in wholesale used car prices, the decline has been somewhat more moderate in CPI, and the decline in used car prices may be disrupted by Hurricane Ian as people seek to replace damaged vehicles at a time when inventories are limited.
Implications for Fed policy and U.S. macro outlook
Continued high core CPI coupled with another strong U.S. jobs report in September add to the case for the Fed to continue to focus fully on fighting inflation. The September CPI report was consistent with PIMCO’s latest Cyclical Outlook, which describes stickier, broader-based U.S. inflation that we believe will take more time and more economic weakness to return to the Fed’s target. The breadth and strength of U.S. CPI will pressure the Fed in coming meetings and support the view that more needs to be done before it can slow the pace of tightening. A 75-bp hike in November is still our baseline, and we believe the latest CPI report suggests the Fed may keep up the pace in December.
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