October consumer prices: Inflation trajectory better but still not good

The October Consumer Price Index (CPI) rose by 0.4% while the core rate (removing the volatile food and energy components) increased by 0.3%. As a result of these moves, the 12-month trend rates moved lower to increases of 7.7% for the overall CPI and 6.3% for the core. The monthly increases – and the resulting trend rates – were less than financial markets expected.

In response to the numbers, financial markets rallied strongly with expectations of future tightening by the Federal Reserve lowered: The S&P 500 Index was up by a bit more than 5.5%, and the yield on the 10-year Treasury note was down by an astounding 30 basis points to around 3.82%. The slowing in core consumer prices was led by a 0.4% drop in commodities, the biggest decline since the heart of the COVID downturn in April 2020 (the core CPI fell by the same amount in March of this year), with used car prices dropping by 2.4%. After surging over the past two years, used car prices are up by only 2.0% over the past 12 months. As computer chips became more plentiful, new car prices responded to increased production and rose by 0.4% for the month, the slowest pace in seven months. The gain in new car prices for the past 12 months is down to 8.4%, the slowest pace in more than a year.

Much of the drop in consumer commodity prices was offset by another large increase in services prices, albeit a smaller one than in the prior month. Shelter costs accelerated, as the lagged impacts of surging house prices and rental costs continue to work their way into the CPI. If not for a likely one-time drop in medical care costs (from lower insurance prices), services costs – and the entire CPI – would have looked much worse. Still, this slower than expected rise in consumer prices and perhaps additional signs that inflation has peaked convinced financial market participants that the Fed will not have to tighten as drastically going forward.

This is almost certainly the case for the Fed at the December Federal Open Market Committee meeting, with a 50-basis-point increase now far more likely than a fifth consecutive 75-bps hike. Indeed, the Fed funds futures market now has some chance of Fed tightening downshifting to only 25 bps. But even this slower pace of inflation is still well above the Fed's 2.0% goal (note that the Fed's goal is based on the broader price index for personal consumption expenditures, which has not been running as hot as the CPI).

The annualized pace of growth for the October CPI was 4.9% – down a lot from its peak, to be sure, but still well above 2.0%. Even the core rate annualized gain for the month, at 3.7%, is too rapid for the Fed. The trajectory is favorable, but inflation has not cooled by enough for the Fed to take its foot off the brake. But maybe the Fed can see if inflation will slow further in coming months with only a tapping of the brakes.

David W. Berson joined Cumberland Advisors in November as Chief U.S. Economist following his retirement as Senior Vice President and Chief Economist at Nationwide Insurance. Contact him at [email protected] or 941-926-6279.