More Fed Hikes In Play With Inflation Looking Sticky Again

From our latest US Inflation Insight: Combined with September’s strong payrolls report, the latest CPI reading adds additional doubt to the theory that inflation will return to the Fed’s 2% target without further monetary tightening being required. Disinflationary momentum has stalled again after good progress in June and July, and the past two months have not offered “clear and convincing” evidence that underlying inflation is on the right track. Overall the downward momentum on core CPI has started to stall: the 3 month annualized rate ticked back up to 3.1% from 2.4% in August, while the 6-month equivalent ticked only slightly lower to 3.6% vs 3.7% in August – the weakest fall in 4 months.

• The data comes at an especially awkward pivot point for Fed communications, with multiple senior officials commenting in the past week that the rise in long-end yields is potentially substituting for another rate hike.
• Doves will point to multiple mitigating factors, with some of the aforementioned “noise” potentially abating in the coming months, and expectations that housing inflation will come down. Chair Powell’s Jackson Hole speech at end-August reiterated this expectation (“if market rent growth settles near pre-pandemic levels, housing services inflation should decline toward its pre-pandemic level as well”). But the FOMC will probably have to see better progress in metrics excluding housing before it settles into a true “pause” stance.
• And while some “noise” in the data may abate in the months ahead, factors that have acted as a disinflationary drag (including in medical categories, and used cars) may no longer be of assistance.
• While it’s doubtful a November hike is in play, the October and November CPI reports will go a long way in setting the tone, the communications, and potentially even the rate decision at the December meeting. The easy part in the 4 road to 2% inflation is over – the debate will soon become how much longer it will take to traverse the last mile from 3-4% annualized inflation.
• That's a key theme of our Policy Team's interview with ex-Richmond Fed President Jeffrey Lacker - he told MNI that policymakers and market participants were lured into a sense of complacency after a couple months of inflation reports showed price pressures dissipating: “That’s now looking a bit transitory. It looks like the run rate is somewhere between 3 and 4-½. That supercore number is looking kind of firm too." As such, "It could be untenable to not raise rates".