The October US CPI was a relief to markets. Global bonds and stocks extended their rally which began just before the last FOMC meeting 2 weeks ago. Interest futures priced out any chance of another rate hike, and started to price in rate cuts by mid-2024.
In public at least, members of the FOMC are pushing back: after all headline inflation is still up 3.2% on the year, while core inflation of 4% is stil double the Fed's target.
Underneath the hood, however, you can see that housing costs are the main reason inflation is still above target. Core CPI less shelter rose by 2% on the year in October, up slightly from 1.9% in the previous month (Figure 1). If you look at headline inflation the story is even brighter: of the 3.2% YoY headline inflation figure, 2.4% is contributed by Shelter (Figure 2).
Shelter has a huge weight in the CPI for All Urban consumers: 35% of the total and 44% of core CPI. The FOMC cares more about PCE inflation of course, which has a roughly 15% weight on housing costs. But here too, it's likely that core inflation will be close to target excluding costs of shelter when the data is published later this month. As we all know the way shelter costs are measured by the statisticians lags way behind the reality on the ground and in CPI terms the contribution from shelter costs should fall by 1-1.5 percentage points over the next 12-18 months (See figure 3). Unless other components of inflation pick re-accelerate that will brings us down to target in terms of the published data, matching what is arguably already the case on the ground.
Transportation Services is really the only other significant category where inflation remains unusually high. The culprits are the cost of car insurance (up nearly 20% over the past year) and vehicle repairs and maintenance. This is currently a shortage of maintenance workers in the car repair sector, especially those qualified to service and repair electric vehicles. And that in turn has pushed up the cost of vehicle insurance.
So to say that inflation is still far from target doesn't make much sense, and nor would tightening policy further to address what aremicro aspects of the inflation process that require supply side solutions more than they require demand restraint.
Another inflation indicator we like uses the output price measures from the PMIs (weighted 60/40 to services and manufacturing). It has been a pretty good guide to the 6 month annualised rate of headline inflation in the past - and that too indicates that prices pressures are receding back to more normal pre-COVID levels (Figure 4). That's also consistent with the idea that productivity growth is actually nearer 2% per annum right now than 1%, which means that wage and employment costs running around 4-4.5% over the past year, and an bit less in recent months, would also be consistent with underlying inflation around 2%.
None of this says that inflation and wage growth can't re-accelerate from here, but it doesn't feel like the central case either. So it looks like inflation was mostly "transitory" after all, but that the Fed is too embarrassed to say so!
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