Posted by Jeffrey J. Roach, PhD, Chief Economist
Thursday, November 10, 2022
Finally, an Encouraging Report
After many months of inflation coming in above expectations, investors finally got a more favorable report with the October Consumer Price Index (CPI) data and are cheering it with a big stock market rally on the news.
Both core and headline inflation rose less than forecasted, pushing the annual rates down considerably from the previous month. In October, the annual headline inflation rate eased to 7.7% from 8.2% in September. Core CPI, which excludes food and energy, rose 6.3% from a year ago. The economy is still finding its balance after multiple supply shocks from a pandemic and a war, but we may soon see a more broad-based deceleration of consumer prices.
Sticky
Shelter costs rose in October and contributed to over half of the rise in total inflation this month. As the housing market cools, this category will also ease but we may have to wait until next year before it meaningfully dampens headline inflation. Shelter costs, along with other services prices, are generally stickier than goods prices and will take time to reverse the previous year’s trend. But some services categories have turned over – medical care prices declined for the first time since the middle of last year and total services prices, excluding rents, fell in October from a month ago, the first time since May 2020. These are encouraging signs as these recent moves have pulled the annual growth rate down (see light blue line in chart below).
No Surprise Here
Goods prices continue to lead the way downward. Used car prices declined for the fourth consecutive month, adding downward pressure on goods prices. Clothes prices declined month over month for the second consecutive month as general merchandise stores manage bloated inventories. Furniture and appliance prices also declined as the housing market slows. Demand for housing-related items should continue to soften in the coming months.
Rising Rents Continue
Rents will likely peak very soon since some of the industry data show falling monthly prices. As of October, rent prices are up 7.5% from a year ago, the fastest annual rate since the early 1980s. The massive reshuffling in the housing market explains most of the rise in rental costs. During the recent period of unusually low mortgage rates, housing demand skyrocketed and home price appreciation reached new levels. High housing costs pushed many homes out of reach for would-be millennial buyers and for first-time buyers with no pre-existing home equity. High demand for homes and low supply created insurmountable hurdles and pushed many to be renters instead of home buyers.
Conclusion
Headline inflation is likely past its peak, but the Federal Reserve (Fed) still has work to do. The easing inflation measures give the Fed some leeway as it begins to downshift from the recent aggressive pace of rate hikes. As policy makers get convincing evidence that inflation is easing, the Fed will likely be on track to increase the fed funds rate by 0.50% on December 14. The October price deflator, the Fed’s preferred inflation metric, will be released on December 1 and will also play a role in the expected path of the rate hikes. Most importantly, the Fed will release updated projections after their meeting, which will likely include revisions to growth and inflation. As import prices and producer prices ease, the inflation outlook should improve. As policy makers have publicly indicated, inflation is the primary concern and for now, the Fed is willing to sacrifice economic growth in the near term to get inflation back to the long-run rate of 2%. But in the near term, investors should respond favorably to these encouraging moves in consumer prices.
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