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The consumer price index (CPI) rose 7.7% in October from a year earlier according to the Labor Department, the smallest annual advance since the start of the year. While elevated, that was down from the 8.2% pace in September and below Wall Street expectations. Excluding food and energy, core prices rose 6.3% in October which, too, remains higher than desired, but down from the 40-year high reached the prior month. The consensus called for annual gains of 7.9% and 6.5% in the overall and core measures, respectively. Declines in prices for medical care services and used vehicles kept a tighter lid on prices last month compared to the previous period.
Shelter costs, which comprise about a third of CPI data, rose 0.8% last month, the most since 1990. A surge in the cost of hotel stays helped fuel part of that rise. Mortgage rates on a 30-year fixed loan rose to 7.14% in the week ended November 4, near the highest since 2001 according to the Mortgage Bankers Association. The overall measure of applications, including refinancings, fell to its weakest level since 1997. That seems to create a disconnect between the increase in shelter costs in the CPI data and what is actually happening day-to-day. The difference is that there is a lag between real-time changes and when they are reflected in Labor Market data. A monthly sample for the CPI does not contain every single home in every single region in the U.S. Only a small portion is included in any one month and, because the surveys take awhile to collect, they will naturally lag applications which are being submitted each day. Economists estimate that shelter-related components will likely peak in the next three months. Excluding food, energy and shelter, the CPI actually fell 0.1%, the weakest report since the first half of 2020.
What does this mean for the markets? Excluding food and energy, the cost of goods fell 0.4%. This was to be expected as supply chains repaired and commodity prices retreated from early this year. Services less energy rose 0.5%. This also was not a surprise as people have prioritized travel and events in their post-pandemic lives. This is where things get a little more complex. Services prices are sticky. While a laptop computer may show one price one week then go on sale the next, it is unlikely that the full-body massage or medical procedure is going to go down in price from one week to the next. Car dealers want to move inventory off the lot to make room for the newest model necessitating deals and discounts. The price of a college tuition may not be rising as fast as in previous periods, but it certainly is not going down. That means the Fed will have to continue its interest rate hike path in order to keep a lid on these services.
The silver lining is that they are unlikely to have to boost their benchmark rate as aggressively as they have the past few meetings. According to Fed funds futures markets, the benchmark rate is expected to be increased 50 basis points at the next meeting on December 14. That is down from the 75 basis point pace from the prior three get togethers. The February meeting is currently pricing in somewhere between a 25 basis point and 50 basis point boost. Assuming the pace is 50 then 25 at the next two meetings, that would put the upper end of the target range at 4.75% and mark at 475 basis point increase in 12 months. That would be an unprecedented spike and certainly warrant serious discussion of a pause before the March meeting which falls only six weeks after the February summit.
Markets reacted strongly to the CPI news on Thursday, reversing the negative tone from Wednesday’s trading. Today's markets produced one of the strongest post-inflation release rallies in more than a decade. Short-sellers scrambled to cover their bets helping fuel the surge. This could be an overreaction to the data, and this year has not had a shortage of volatile markets changing course from one day or week to the next. What is promising this time around is that this is the first positive inflation data the markets have received in some time. Previous calls of “peak inflation” did not quite have the solid numerical evidence to really convince traders that a turnaround was in place. This was the first outright decline in core CPI goods prices since March. Adobe Inc., which tracks consumer trends in addition to providing software, said that prices of goods sold online in the U.S. declined for the second consecutive month in October marked by a record fall in the prices of electronics. A handful of Fed governors also said post-CPI release that a downshift may now be appropriate. The Bloomberg economics team “translated” the CPI data to the preferred Fed inflation measure—the personal consumption expenditure index—and determined the headline would be around a 5.8% increase on an annual basis. The actual data from the Labor Department for October will not be released until December 1. In September, the annual increase was 6.2%, so if their translation is correct, it would mark a definite deceleration in a pivotal indicator. But before that reading comes out, there will be producer price index data released next week which would be an opportunity to see whether wholesale prices are showing the same type of slowing down. Retail sales data from the Commerce Department will be released next Wednesday. A concurrent indicator, that information will be important to see if consumers are adjusting their buying patterns before the all-important holiday season. We will also see building permits, housing starts and new and existing home sales before Thanksgiving. The Federal Open Market Committee meeting minutes will be released the day before Turkey Day which hopefully will not cause indigestion for the markets! We will also get another CPI, producer price and payroll report before the Fed meets on December 14 so stay tuned to our weekly reports for the latest data and our interpretation of how markets will react.
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