CPI Components Tell Different Stories
First the good news: The headline October CPI report is the fourth straight month with year-over-year inflation below June’s shocking 9.1% print. In fact, it’s the lowest year-over-year reading since January 2022.
Car buyers could have predicted the deceleration. The used car component of CPI, which was one of the first indicators warning of runaway inflation in 2021, dropped 2.4% in October. Previously owned car prices overall are just 2% higher than this time last year.
Drivers didn’t have a lot to be happy about. Gas0line reversed its declines from the summer, with gas prices up 4% in October. This reversal is likely a result of OPEC+’s decision to reduce crude oil production. Gasoline is now 18% higher than this time last year, in line with overall energy prices.
Related: Inflation Calculator
Other staples of the typical American budget got more expensive, as well. The price of buying groceries and dining out surged in October, and are now 12% and 9% higher than a year ago, respectively. The overall food index gained almost 11%.
Core CPI Looking Hotter than Headline Inflation
There’s a reason why Fed officials and economists use core inflation to get a better read on price trends: Food and energy prices are really volatile, jumping around month to month, even if they are vital to household budgets.
Core CPI demonstrates just how big a task the
Federal Reserve has before it. According to this metric, prices gained 0.3% in the month, and are 6.3% higher than last year. That’s well above the Fed’s 2% target, albeit down slightly from las month’s reading
Shelter costs continued its surge, increasing by 0.8% in the month, and 6.9% over the past 12 months. Economists and market analysts, alike, have been looking for home prices to come down as mortgage rates surge to 20-year highs.
The latest CPI numbers come after some contradictory economic data.
Employers added 261,000 jobs in October, while wages were up 4.7% over the past year. Still, inflation-adjusted earnings were down 2.8% over the same period.
The nation’s gross domestic product dropped for the first two quarters to start the year, which is a common, but not definitive, definition of
recession, but gained 2.6% in the third quarter.
Meanwhile, forward-looking
economic indicators, such as the Conference Board Leading Indicators and the stock market, have struggled mightily throughout the year.
The Commerce Department reported that the core personal consumption expenditures (
PCE) price index, the Federal Reserve’s favorite inflation metric, was up 5.1% in October, which is represents an uptick over recent months and way above the Fed’s 2% target.
Inflation Remains Enemy #1 for the Fed
Inflation has been the Fed’s enemy number one in 2022. The Federal Open Market Committee (FOMC) has made aggressive changes to U.S.
monetary policy to bring inflation down to its long-term target of around 2%.
In November, the FOMC raised its target range for
fed funds by 75 basis points (bps) for the fourth meeting in a row.
While inflation may have peaked, prices are still rising well beyond where the Fed wants, and haven’t come down too dramatically. That’s why looks as if the Fed will raise rates by at least another 50 bps, if not 75 bps, when the FOMC reconvenes in December. Market observers are overwhelming expecting the Fed hikes rates by 50 bps, according to the CME Group’s
FedWatch tool.
Markets are currently pricing in an 80% chance of such a hike bps rate hike, which would bring the fed funds rate to between 4.25% and 4.50%. The market pricing in a 20% chance for a 75 bps rate increase.
“We are preparing for an environment where interest rates remain higher for longer,” said Michael Landsberg, chief investment officer at Punta Gorda, Fla.-based Landsberg Bennett Private Wealth Management. “Investors should be more concerned with the effect that rising rates into a decelerating economy has on their portfolio values rather than the current level of inflation.”
Could Inflation Spark a Recession?
The Fed is facing a difficult balancing act, needing to raise interest rates aggressively to bring down inflation without triggering a U.S.
recession.
Rising interest rates increase borrowing costs for companies and consumers, weighing on economic activity. Up to this point, the U.S. labor market has been solid, but the S&P 500’s 21% year-to-date decline reflects concerns on Wall Street that the economy may not take spiking interest rates in stride.
Growth stocks are particularly sensitive to rising interest rates because fund managers typically use discounted cash flow models to determine their price targets for growth stocks. Future cash flows are considered less valuable when the discounted rate is higher.
So far in 2022, the Russell 1000 Growth Index is down 31%, while the Russell 1000 Value Index is down 11%.
Inflation isn’t necessarily bad news for every
stock market sector, however. Soaring oil, natural gas and other commodity prices have helped energy sector stocks generate record profits in 2022. The Energy Select Sector SPDR Fund (XLE) is up 64% so far this year amid broad-based market weakness.
Today’s report may quash traders’ animal spirits.
“Prices are cooling faster than expected in the US, which makes a 0.75% rate rise next month extremely unlikely,” Samuel Fuller, director of Financial Markets Online. “This is going to calm nerves on both sides of the Atlantic because the data offers the tantalizing promise of calmer waters where rate setters don’t have to wreck economies to bring inflation under control.”
What’s Next?
Investors will be monitoring the Fed’s commentary on the economy at its upcoming meeting. The U.S. Bureau of Economic Analysis (BEA) will release the October PCE reading on Dec. 1. CPI and PCE
measure inflation based on pricing a basket of goods.
The two baskets are different, and the formulas used to calculate each measure are not the same. The CPI calculation is based on a survey of goods consumers buy, whereas the PCE is based on a survey of goods businesses sell.
It’s important to remember today’s release is but one data point, and the Fed will digest more information before its next confab.
The Fed is trying to lower inflation without harming employment too dramatically. This report shows that it has many more miles to go.
