October CPI: Small Surprise, Large Market Reaction

U.S. inflation cooled more than expected, and bond markets rallied, but the Fed is likely to remain in a long pause.

October’s U.S. Consumer Price Index (CPI) release likely reinforced the Federal Reserve’s resolve to pause as the effects of tighter monetary policy continue to work through the economy. Indeed, core U.S. inflation cooled more than many observers expected, rising just 0.23% in October. This wasn’t far below consensus, yet the welcome surprise sparked a meaningful immediate rally in bond markets. It was also good news for Federal Reserve policymakers, who may now be more comfortable with the prolonged pause they’ve signaled.

October’s U.S. data for both inflation and employment align with our view that growth momentum and inflationary pressures are fading. In this “Post Peak” economy (as we discuss in our latest Cyclical Outlook), cracks are beginning to appear in the U.S. resilience that bolstered growth and pressured term premia through much of this year. However, we still believe that a period of below-trend growth is likely necessary to bring inflation sustainably back to the Fed’s 2% target. The bond market rally following the CPI data release suggests investors are increasingly mindful of the shifting macro trends.

October CPI details

The main drivers of softer inflation for the month include owners’ equivalent rent – a gauge of what homeowners could charge for rent – which came in lower after a surprise reacceleration in September, while rental inflation remained steady. Travel prices remain volatile, surprising to the downside in October. Core goods prices fell, due in part to retail discounts in some categories, along with softer new and used car prices. Energy prices dropped notably, contributing to a flat reading for headline CPI in October.

By contrast, medical services, including health insurance, saw prices rise in October; food prices also edged higher.