Strong US inflation points to a December Fed rate rise

The Fed remains on track to resume raising rates in December given high core inflation, upside risks to inflation and no slack in the labour market. Annual core inflation is actually tracking slightly below the FOMC’s earlier forecast profile, but the CPI pointed to another strong monthly rise in the core PCE deflator in October, raising the odds of a December hike. Fed Governor Waller has suggested the FOMC should consider a 50bp rate rise, although the majority of the FOMC will likely opt for a 25bp increase while signalling further tightening. Simple policy rules based on the Fed’s current outlook still point to a peak in the funds rate of about 4½% in rounded terms, although a material slump in stock prices would alter this calculation. 

• The Fed should resume raising rates in December, barring a slump in stock prices.
  Policy rules continue to point to a peak in the funds rate of about 4½% in rounded terms based on the FOMC’s current economic outlook, such that the Fed should resume raising rates next month given still-high inflation, no estimated slack in the labour market, and upside risks to inflation. The FOMC meets on 8-9 December, when it will also update its economic outlook, returning in the new year on 26-27 January (note that the FOMC will meet eight times next year, but will decide on policy only seven times because Fed Chair Warsh wants to devote one meeting to discussing strategy). Core inflation is actually tracking slightly below the FOMC’s median forecast profile, mainly because of the BEA’s recent downward revision to how it measures prices for tech and professional services, but another likely strong monthly reading in October raises the odds of a December rate rise. The main risk to this view is a material decline in stock prices, which could change the Fed’s mind about the outlook for the AI boom.

• Fed Governor Waller has suggested the FOMC should consider a 50bp rate rise, although the majority of the FOMC seems likely to stick to a 25bp rate rise.
  Interestingly, Fed Governor Waller – who was an unsuccessful candidate for Fed Chair and who has reportedly argued that Fed Chair Warsh’s various taskforces are a waste of time – has proposed raising rates by 50bp in December. Waller said shortly before the release of the CPI, “if the October CPI inflation data … are similar to the past two monthly readings—with core CPI inflation around 0.3% or even higher, then a stronger policy move may be needed, [and], in that case, I believe a 50bp hike in the policy rate should be considered at the December meeting [because] hiking only 25bp would put our credibility at risk, a risk I am not eager to take”. While Waller might dissent in favour a of a large rate rise, most of his colleagues are likely to vote for a 25bp increase, while signalling further tightening in the new year (excluding the pandemic years, the last time the Fed raised rates by 50bp was at the end of the 1999-00 rate hike cycle when the dotcom bubble started to unravel at a faster pace).
  
  
• The core PCE deflator – which is the Fed’s preferred measure of underlying inflation – looks to have posted another strong increase in October based on detail of the CPI.
  The core CPI rose by 0.3% in October, translating to an increase of between 0.3-0.4% in the core PCE deflator, which is the Fed’s preferred measure of underlying inflation, up from an increase of 0.3% in both August and September. As usual, this preliminary estimate will be revised pending the PPI and import prices on Friday and Monday, where the average absolute error of the final nowcast is about 0.1pp.
  
  
• The core CPI posted another strong rise in October.
  In terms of the detail, the core CPI rose by 0.3% for the third month in a row in October, with annual inflation picking up from 2.6% to 2.8%. Core goods prices rose by 0.2% after a 0.3% increase in September and are 0.8% higher than a year ago. The impact of tariffs on goods prices is fading, but there is likely some pass-through from high and volatile energy prices. Core services prices rose by 0.3% in October after a 0.4% increase in September (0.4% excluding housing) and are up 3.4% over the past year (the same excluding housing). An alternative measure of core inflation, namely, the trimmed mean CPI, rose by 0.4% in October, up from 0.3% in September, and is 2.9% higher than a year ago.