Surging September CPI Bolsters Case for Further Outsize Fed Hikes

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.