The Inflation Fever May Have Finally Broken
- The Consumer Price Index was unchanged in October and is now up just 3.2% year-to-year.
- Both headline and core inflation came in 0.1 percentage point below the consensus.
- Headline inflation was held in check by a 5.0% drop in gasoline prices. Food prices rose 0.3%, which is slightly larger than in recent months.
- Prices excluding food and energy items rose 0.2%, the smallest rise since September 2021.
- Core inflation was held back by another large drop in used car prices, which fell for the 5th consecutive month.
- Core goods prices fell 0.1%, while core services prices rose 0.3%.
- Shelter prices moderated, mostly due to a huge 2.5% drop in lodging costs.
- Bottom line: October’s better-than-expected CPI report sparked a huge rally in the financial markets, which had feared an upside surprise. While the latest data may overstate the extent of the improvement, the moderation in price increases was broad-based.
October continues to shape up as a transformation month. The month began with a weaker ISM manufacturing report that was followed by surprisingly soft employment gains. Today’s data show inflation moderating across most key areas. Headline inflation was held in check by a 5.0% plunge in gasoline prices, while core inflation was held back by price declines for used cars and trucks, new vehicles, hotel rooms and airline fares. Moreover, a much discussed rebound in health insurance costs proved to be far less menacing than was widely feared.
The overall CPI rose 0.045% in October, or roughly unchanged. This marks the best reading for the CPI since July 2022 and brought the year-to-year gain back down to 3.2%. The CPI peaked at 9.1% in June 2022.
Prices excluding food and energy items rose 0.2% and are now up just 4.0% year-to-year, the smallest rise since August 2022. The core CPI was restrained by declines in prices for lodging (-2.5%), used car and truck prices (-0.8%), and airline fares (-0.9%).
Despite the better headlines, prices continue to rise sharply for a handful of items, including motor vehicle insurance (+1.9%), health insurance (+1.1%) and admissions to sporting events (+3.6%). The latter follows a 7.7% rise in September and puts sporting event ticket prices up a whopping 25.1% year-to-year.
The easiest part of bringing inflation back down to the Fed’s 2% target is likely behind us.
Prices for core services (services less energy) rose 0.3% in October. Rent of primary residence rose 0.5% and owners’ equivalent rent rose 0.4%, which remains well ahead more recent market measures of housing costs.
While it is always dangerous to make too much out of any single report, we believe October’s better than expected CPI report will prove to be a harbinger of a more benign inflationary environment going forward. Price increases are moderating broadly, which is evident in the smaller gains in Cleveland Fed’s median and trimmed-mean CPI measures. The moderation also coincides with a whole host of reports suggesting economic growth throttled back in October.
Slower economic growth is driving down commodity prices, with marked declines in oil and other key industrial and agricultural commodities over the past month. This reduction in commodity prices is expected to contribute to a continued deceleration in overall inflation and further restrain core goods prices, leading to additional improvement in the core CPI.
Further reducing core service prices will be the harder part in returning inflation to the Fed’s 2% target. Services excluding energy services account for 58.5% of consumer spending and have moderated only slightly since peaking at 7.3% in March. Prices are moderating, however, and should continue to do so.
Labor costs, a significant component of core services prices, remain a notable headwind. The substantial wage gains won from the UAW strike and a few others will add to the challenge. The broader labor market is cooling, however, indicated by a declining quits rate and smaller gains in average hourly earnings.
Housing is another area where prices have only begun to moderate. Shelter costs rose 6.7% over the past year, accounting for over 70% of the total increase in the core CPI. Rent of primary residence and owners’ equivalent rent rose just slightly more than that, climbing 6.8%. Both peaked 6 months ago and are now trending lower. Private measures of home prices and apartment rents peaked about 18 months ago and have decelerated much more significantly.
The housing costs measure in the CPI tends to lag at least a year behind market measures.
Housing cost will likely moderate further in 2024. Apartment developers are set to deliver a slew of new apartments across the country, which will further depress apartment rents.
Fed Chair Jerome Powell has repeatedly said the Fed’s next move is more likely to raise interest rates rather than lower them. Powell is basically talking the Fed’s book, hoping the financial markets will do the Fed’s work for them. October’s softer economic data and lower inflation print suggest a shift to a neutral bias at the December FOMC meeting, putting the Fed on a trajectory to cut rates around the middle of next year.
Disclaimer: This publication has been prepared for informational purposes only and is not intended as a recommendation offer or solicitation with respect to the purchase or sale of any security or other financial product nor does it constitute investment advice.