Freedom: inflation surge increased the risk of October Fed tightening

September inflation data increased the likelihood of a Fed rate hike as early as October; however, Freedom Broker’s base-case scenario remains a December tightening. Macroeconomist Yuriy Ichkitidze believes that a significant portion of the deviation from the forecast is related to the specifics of calculating housing costs, while more persistent pressure is being created by second-round effects from expensive oil.

According to data from the U.S. Bureau of Labor Statistics, consumer prices in September rose by 0.6% month over month and by 3.7% year over year. The core index, excluding food and energy, increased by 0.3% month over month and by 2.6% year over year. 

Core inflation came in above forecast

Measured with greater precision, the monthly increase in the core index was about 0.33% versus the analysts’ average forecast of 0.2%. Freedom expected an increase of 0.21%.

According to Ichkitidze’s calculations, the housing component accounted for more than half of the overshoot versus Freedom’s forecast. It explains about 0.074 percentage points of the total deviation of 0.125 percentage points. Another 0.029 percentage points came from core goods—non-food goods excluding energy. Transportation and medical services also rose more than expected.

The housing component does not necessarily point to a sustained acceleration in prices

A significant part of the housing component is owners’ equivalent rent. This is an imputed estimate of how much homeowners would pay to rent a similar property, rather than their actual cash outlay.

Ichkitidze notes that this measure carries a large weight in the consumer price index. In the personal consumption expenditures price index, which the Fed focuses on when assessing its inflation goal, its impact is noticeably smaller.

In the economist’s view, September’s jump in this component may be followed by lower monthly readings. Therefore, he does not see it as sufficient confirmation of a sustained strengthening of inflation.

Expensive oil also affects core inflation

Freedom sees a more significant source of pressure in rising prices for certain goods and services following the increase in oil and transportation costs.

Although energy is directly excluded from the core index, higher energy prices raise production and delivery costs. Businesses may pass these costs on to final prices, so the oil factor shows up beyond the fuel component as well.

At the same time, Ichkitidze does not see a broad-based acceleration of inflation. In categories where the impact of transportation costs and expensive fuel is weaker, price growth is restrained by modest household income dynamics.

December remains the base timing for a rate hike

Freedom estimates that the Fed’s ability to combat this kind of inflation acceleration is limited. A rate hike can cool business investment and consumer spending, but it does not eliminate the reasons behind higher oil prices. Therefore, additional tightening could have a stronger impact on economic growth than on the source of price pressure.

At the time the report was prepared on October 15, futures priced the probability of an October rate hike at about 30%. Ichkitidze allows that the Fed may prefer to wait for new data and raise rates only in December. An argument for a pause remains the previously published softer August data on the personal consumption expenditures price index.

Earlier, Freedom Broker had already called a December rate hike the base-case scenario. At that time, the economist noted that actual inflation had come in below the regulator’s expectations. The new consumer price report increased uncertainty but has not yet changed Freedom’s main forecast. 

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