Hot August Inflation May Shift Fed’s Interest Rate Trajectory Higher

The U.S. had another scorching CPI (Consumer Price Index) report. Stickier and broader-based inflation through August suggests the Federal Reserve has more work to do to contain price increases, and the odds of a hard landing for the U.S. economy continue to rise. We may see a faster pace of Fed rate hikes to a higher terminal fed funds rate than what was previously expected.

After the July CPI report set up some hope that both headline and core inflation were moderating, the August CPI report significantly outpaced consensus expectations. More concerning, the details were firm, with broad-based reacceleration in prices across most goods and services categories. Given the softening price news in several high-frequency indicators in recent months (purchasing managers’ indexes (PMIs), shipping, retail inventories, Manheim used car index, etc.), even after adjusting for the usual lags, it seems easing input prices are not yet filtering through to consumer prices. This suggests many companies are maintaining price markups via a slower pass-through of easing input costs, consistent with the view that it’s going to take more time for inflation to moderate.

Inflation report details: rent, retail, cars, travel

U.S. rental inflation measures were once again extremely strong in August, as rents and owners’ equivalent rents (OER) both reaccelerated 0.7% month-over-month (m/m), slightly more than expected. We continue to expect the year-over-year rate of rents and OER to accelerate up to 8% – well above the 3.5% pre-pandemic trend. Counterintuitively, Fed rate hikes historically have tended to boost rental inflation at first, because they make owning a home less affordable, consistent with the behavior seen over the past several months. It’s not until housing price inflation starts to more materially moderate that rental inflation also starts to fall (typically after three to six quarters). Furthermore, with a general absence in rent controls outside of major U.S. cities, price adjustments in lease renewals have been much stronger in the face of high price hikes for lease turnovers, resulting in a higher “beta” than we’ve witnessed historically. This has also boosted the reported rate of rental inflation, since the Bureau of Labor Statistics (BLS, which publishes the CPI) surveys both lease renewals and turnovers. Given that these rental measures make up such a large part of the CPI basket and will take time to moderate, it underscores the challenge Fed officials are facing over the next several quarters.

Goods price inflation reaccelerated in August after the small reprieve in July (which likely reflected discounting related to Amazon Prime Day). Furnishings (+1.1% m/m), apparel (+0.2% m/m), and recreation goods (+0.6% m/m) all saw notable reacceleration. Despite significant improvement in logistical bottlenecks and a surge in inventory/sales ratios for most U.S. retail goods, consumer inflation across goods categories has been very sticky. This suggests retailers were quick to adjust prices on the upside, but have been more cautious about passing along easing input price pressures to consumers, as they face margin pressures from rising labor costs and lower volumes.