Inflation heated back up in September, putting the prospect of an interest rate hike this month back on the table as Federal Reserve officials consider the extent and timing of future hikes.
The Consumer Price Index rose 3.7% in September, compared with expectations for 3.6%, and an acceleration from 3.4% in August. Month-over-month prices rose 0.6%, versus expectations for 0.5%. Stripping out volatile food and energy prices — the way the Fed likes to scrutinize underlying inflation — CPI rose 0.3% month over month, compared with expectations for 0.2%, holding the same level as August. The year-over-year rate was 2.6%, compared with expectations for 2.5%, and up from 2.4% in August.
A big surge in gas prices accounted for over half of the increase. Gas prices rose 9.1% in September, while the energy index as a whole increased 5.2% following a 2.1% increase in August.
Markets were not yet pricing in a likelihood that the Fed will hike rates later this month on the back of the hotter-than-expected CPI report. According to CME Group, traders see just a 43.7% chance of a quarter-point hike on Oct. 28, up from about 20% before the inflation report. However, the yield on the 10-year Treasury (^TNX) was moving higher, cresting above 5.3% on Wednesday morning.
Markets are pricing in better than 50% odds that the central bank hikes rates for a second time this year in December.
“The upside surprise to core CPI in September was broad-based rather than due to any obvious temporary factors, therefore bringing an October rate hike back into play and presenting upside risks to our forecast for just two more 25 bp hikes from the Fed,” said Stephen Brown, chief North America economist for Capital Economics.
Feeding into core inflation, September saw the largest-ever monthly rise in toy prices, which jumped by 4.2%, as well as a stronger 0.7% rise in used vehicle prices, while apparel prices rose by 0.3%, and IT equipment also increased. There were broad increases elsewhere too, with shelter prices rising by a firmer 0.4% due to another strong 2% rise in lodging prices and a firmer average gain in primary rent and owners’ equivalent rent of 0.30%.
“Inflation pressures are broadening beyond energy, suggesting the last mile back to target could remain bumpy and keep interest rates elevated,” said Jeffrey Roach, chief economist for LPL Financial. “The latest report complicates the Fed’s decision this month, as the road back to price stability is looking increasingly difficult to navigate.”
Roach said monthly core inflation needs to consistently run in the 0.1% to 0.2% range before the Fed can reasonably conclude that inflation pressures are contained.
A chorus of Fed officials has been calling for further rate hikes to bring down inflation, which has remained above the Fed’s 2% target for over five years, while leaving flexibility on when those hikes might occur.
“If the economic data continue to come in as expected, I anticipate additional hikes to support a timelier return of inflation to our 2% goal,” Fed governor Chris Waller said earlier this month. “But there is some flexibility about when those hikes will occur. The hikes do not need to come at consecutive meetings, but they should be in place in an acceptable period of time.”
The Boston Fed’s Susan Collins said Tuesday that it would “be appropriate to raise rates a bit further before the end of the year to ensure a timely and durable return of inflation” to the Fed’s 2% target. She also said the timing would depend on the data.
Cleveland Federal Reserve president Beth Hammack said Monday that inflation is broad-based and will take time to come back down, even with a boost in interest rates. Hammack said she is looking toward more frequent, smaller rate adjustments to ensure an inflationary mindset doesn’t take hold.
However, Fed Vice Chair Philip Jefferson and New York Fed president John Williams have tempered expectations for a rate hike later this month. Both have struck a more cautious tone than several of their colleagues, acknowledging that inflation has remained too high, but that the central bank should take time to watch and assess whether inflation will come down in a timely manner.
Williams told Bloomberg on Tuesday that he still sees one more interest rate hike as appropriate this year, but at the moment, he doesn’t believe the central bank will need to raise rates again in 2027.
Minutes from the Fed’s September policy meeting revealed that most policymakers thought another rate increase would “likely be appropriate by year end.”
Capital Economics’ Brown noted that he believes the broad-based move in core CPI is likely to be reflected in the Fed’s preferred inflation measure — the core Personal Consumption Expenditures index, which he estimates is 0.32%. If that ends up being true, that would cause the three-month annualized rate to rebound 2.8% from 2% in August, which could prompt the Fed to pull the trigger on another hike this month.
Still, while the odds of a rate hike seem higher, others think the Fed could take time to digest the inflation data.
Christopher Hodge, chief economist at Natixis, said he thinks avoiding a hike in October is prudent because it would allow time to further assess economic variables by the December meeting, as well as avoid the political fallout from hiking just before midterm elections in early November.
“Ultimately, we think the Fed will pause when it meets in a few weeks, but today’s data at least gives the hawks more ammo, and if markets continue to price in a hike, the FOMC may be loath to surprise with a hold,” said Hodge.
Jennifer Schonberger is a veteran financial journalist covering markets, the economy, and investing. At Yahoo Finance, she covers the Federal Reserve, Congress, the White House, the Treasury, the SEC, the economy, cryptocurrencies, and the intersection of Washington policy with finance. Follow her on X @Jenniferisms and on Instagram.
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