The era of steadily climbing inflation may be over, but high prices will likely stick around for a while longer.
Hopes that inflation would start to decline were dashed when the Labor Department reported that the September consumer price index (CPI) rose 8.2% over the prior 12 months, higher than what experts had predicted.
While that’s a slight dip from this summer’s readings, prices remain very high. On a month-over-month basis, CPI rose 0.4% in September—following a much softer 0.1% monthly gain in August.
Food prices, housing, and medical care saw higher price increases. At the same time, the gasoline price index fell by 4.9% in the month, the third straight monthly decline, furthering a late summer decline.
So-called core CPI, which strips out volatile food and energy prices, rose by a robust 0.6% in September, matching its August jump. September core CPI grew by 6.6% over the prior 12 months.
Sustained core inflation gives the Fed fodder to continue with its hawkish policy, especially as the labor market continues to hold up well. The inflation report comes after the Federal Reserve raised interest rates to a range of 3.0%–3.25%, a dramatic increase in a short period.
“Today’s CPI report came in hot, and higher than expectations, driving rates higher and stocks down,” said Mace McCain, CIO of Frost Investment Advisors. “The market was hoping to see a moderation in inflation, but that isn’t the case and leaves the Fed on their path of higher for longer.”
CPI Inflation Is Leveling Off
First the good news: The headline September CPI report is the third straight month showing year-over-year inflation that’s below June’s shocking 9.1% annualized CPI print.
Drivers could have predicted the decline. The gasoline component of CPI is slowly decelerating, up a mere 7.6% on an annualized basis in September, a sharply lower gain than the 11.2% figure in June. Overall, energy prices dropped 2.1% on a month-over-month basis.
Car owners, though, shouldn’t get too comfortable. Recall that gasoline prices dropped 6.1% in April, before lunging higher in subsequent months. Gasoline prices in September were still 18.2% higher than 12 month prior. Natural gas prices were also higher, an ominous sign as winter approaches.
Related: Inflation Calculator
The news was less cheerful when it comes to another staple: food.
The price of buying groceries and dining out surged again in September, and are now 13% and 8.5% higher than a year ago, respectively. The overall food index gained 11.1%, close to last month’s figure that was the biggest 12–month jump since May 1979.
Core CPI Looking Hotter than Headline Inflation
There’s a reason why Fed officials and economists use core inflation to get a better handle on price trends: Food and energy prices are really volatile, jumping around month to month, even if they are vital to household budgets.
Core CPI demonstrates just how big a task the Federal Reserve has before it. According to this metric, prices gained 0.6% in the month, and are 6.6% higher than last year. That’s well above the Fed’s 2% target, and higher than last month’s 6.3% reading.
The shelter was a major driver here. Housing prices grew 0.7% in September and are up by 6.6% compared to a year prior.
The latest CPI numbers come after some contradictory economic data.
Employers added 263,000 jobs in September, while wages were up 5% over the past year. Still, inflation-adjusted earnings were down 3% over the same period. The nation’s gross domestic product dropped for the first two quarters to start the year, which is a common, but not definitive, the definition of recession, but is posed to pick up speed dramatically in the third quarter.
Meanwhile, forward-looking economic indicators, such as the Conference Board Leading Indicators and the stock market, have struggled mightily throughout the year.
The Commerce Department reported that the core personal consumption expenditures (PCE) price index, the Federal Reserve’s favorite inflation metric, was up 4.9% in August, which is well below the February reading of 5.3%.
That’s way above the Fed’s 2% target, and higher than the July reading.
Inflation Remains Enemy #1 for the Fed
Inflation has been the Federal Reserve‘s enemy number one in 2022. The Federal Open Market Committee (FOMC) has made aggressive changes to U.S. monetary policy to bring inflation down to its long-term target of around 2%.
In September, the FOMC raised its target range for the federal funds rate by 75 basis points (bps) once again.
While inflation may have peaked, prices are still rising well beyond where the Fed wants, and haven’t come down too dramatically. That’s why looks as if the Fed will raise rates by another 75 bps when the FOMC reconvenes on Nov 1-2. Market observers are expecting the Fed hikes rates by 75 bps, according to the CME Group’s FedWatch tool.
Markets are currently pricing in a 98% chance of such a hike bps rate hike, which would bring the fed funds rate to between 3.75% and 4%. The market pricing in a 2% chance for a 100 bps rate increase.
“As inflation remains elevated, the Fed will continue to raise rates to combat high inflation to bring it back to near their 2% mandate,” said Gargi Chaudhuri, Head of iShares Investment Strategy Americas.
Could Inflation Help Spark a Recession?
The Fed is facing a difficult balancing act, needing to raise interest rates aggressively to bring down inflation without triggering a U.S. recession.
Rising interest rates increase borrowing costs for companies and consumers, weighing on economic activity. Up to this point, the U.S. labor market has been solid, but the S&P 500’s 25% year-to-date decline reflects concerns on Wall Street that the economy may not take spiking interest rates in stride.
Growth stocks are particularly sensitive to rising interest rates because fund managers typically use discounted cash flow models to determine their price targets for growth stocks. Future cash flows are considered less valuable when the discounted rate is higher.
So far in 2022, the Russell 1000 Growth Index is down 31.4%, while the Russell 1000 Value Index is down 17.3%.
Inflation isn’t necessarily bad news for every stock market sector, however. Soaring oil, natural gas, and other commodity prices have helped energy sector stocks generate record profits in 2022. The Energy Select Sector SPDR Fund (XLE) is up 49% so far this year amid broad-based market weakness.
Today’s report may quash traders’ animal spirits.
“The worst fears are playing out as inflation spreads,” said David Russell, VP of market intelligence at TradeStation Group. “It started in goods and is now firmly established in services like healthcare and food away from home. Price increases are spreading like coronavirus in early 2020 with cases popping up across the country. This is the Fed’s worst-case scenario and keeps them on track for more aggressive hikes.”
What’s Next?
Investors will be monitoring the Fed’s commentary on the economy at its upcoming meeting. The U.S. Bureau of Economic Analysis (BEA) will release the September PCE reading on Oct. 28. CPI and PCE measure inflation based on pricing a basket of goods.
The two baskets are different, and the formulas used to calculate each measure are not the same. The CPI calculation is based on a survey of goods consumers buy, whereas the PCE is based on a survey of goods businesses sell.
It’s important to remember today’s release is but one data point, and the Fed will digest more information before its next confab.
The Fed is trying to lower inflation without harming employment too dramatically. This report shows that it has many more miles to go.
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