Not good or not bad?

Equity markets have had a hard time deciding how they feel about the US CPI data for September, which were released this morning by the Bureau of Labor Statistics.  Stocks initially sold off sharply, with the DJIA more than 500 points lower, as the higher-than-expected monthly increase pointed to further aggressive Fed rate hikes, only to rally to an 800-point gain as the data were more fully digested. A look at the data themselves shows that there is plenty of scope for competing interpretations.  

Headline CPI rose 0.4 percent in the month, against market expectations of a 0.2 percent gain. This meant that the widely followed year-on-year rate edged down by just one tick, to 8.2 percent. This is a politically important number for the Biden administration, this being the last CPI report before the mid-term elections. 

But there are other ways of looking at the headline data. The 0.4 percent September print comes in the wake of essentially flat results for the two preceding months, meaning that the annualized "running rate" of inflation for the third quarter as a whole was not far from 2 percent, which is of course the Fed's target. The outsized monthly increases seen earlier in the year seem to be over.  Although it will take some time for the year-on-year numbers to reflect that, it is possible to make a case that the Fed is winning the inflation battle and can afford to take a more cautious policy approach going forward.  

That being said, the core CPI data tell a less encouraging story. That measure, which excludes energy and food prices, has shown no signs of the deceleration evident in the headline number. It increased 0.6 percent in September, the same as in August and in line with the pace seen since the start of the year. The year-on-year increase stood at 6.6 percent, the largest since August 1982. This evidence of continuing broad-based price pressures could lead the Fed to continue with the very aggressive tightening seen so far this year, and that was certainly the markets' interpretation immediately after the numbers were released. 

Faced with this mixed bag of data, which way will the Fed go at the next FOMC meeting, set for November 1-2?  There is a growing chorus of commentators warning that the Fed is risking a severe recession by pursuing an aggressive tightening policy that can do little about the underlying causes of the recent inflation spike. Recent rhetoric from Fed officials suggests that they are not being swayed by this line of argument, so another large move is on the cards.  

Just as an afterthought, today's numbers have an impact on Canada too. The Canadian dollar sold off after the CPI release, on expectations that the Bank of Canada may not look to match the expected pace of Fed tightening.  Persistent weakness in the exchange rate would soon spill over into Canadian inflation data. Canada's September CPI data, due for release on October 19, are likely to show some further moderation, but that may not be sufficient to keep the Bank of Canada from tightening further.