Issue 106: US CPI Disappoints

This Week’s Highlights

• Sticky inflation in September
  Data out of the BLS last week showed headline inflation falling less than expected and core inflation actually rising from August to September, driven by sticky shelter costs. That was bad news for bets on the Fed to make another half-point cut at its meeting in November.
• US jobless claims on the rise
  The Labor Department also dealt a blow to the flipside of the Fed’s dual mandate last week, as Hurricane Helene spurred the biggest weekly increase in initial jobless claims in over a year: a sign of the economic toll increasingly frequent natural disasters can take.
• ECB minutes tip further cuts
  I​​​​n Europe, traders parsing a readout from the ECB’s September meeting found policymakers facing the same sticky inflation as the Fed, but also contending with slowing growth. That should be enough to keep rate cuts coming at each of the ECB’s next two meetings.

The CIO’s Take:

• Even as macro data in recent months increased our confidence the US will avoid a recession, we’ve been very clear that a big risk to bullish sentiment is inflation, which we expected to get stickier as the Fed’s 2% target approaches. Seeing that risk materialize, we’re doubling down on our bet that the Fed moderates the pace of its easing.
• While a move back up in core inflation is worth watching, we’re not reading too much into the weekly pop in jobless claims, which we think analysts are rightly attributing more to the storm and a strike by machinists at Boeing. As such, we remain confident US jobs are softening at a pace that should give the Fed room to cut less aggressively.
• ​​​The ECB is in a tougher position, with sticky services inflation raining on headline CPI’s parade, while the big-three Euro Area economies—Germany, France, and Italy—all recorded simultaneous contractions in September. We expect the ECB to focus on supporting growth with more easing, though it might not be able to avoid a recession.​​​​​​

US CPI Disappoints

Headline inflation falls slowly
The US Bureau of Labor Statistics (BLS) released September inflation data Last Thursday, and the report was something of a mixed bag. Headline CPI slowed for the sixth consecutive month, ticking down to 2.4% from 2.5% in August, the lowest reading since February 2021. That’s a positive in the sense that we’re still making incremental progress toward the Fed’s 2% target, but economists were expecting 2.3%, making September’s print an upside surprise. Likewise, the month-over-month increase in prices was identical to August’s 0.2% rise and higher than economists’ 0.1% estimate.

September core CPI ticks up
Unfortunately, a big chunk of September’s disinflation came from the 4.1% drop in gas prices during the month. Indeed, year-over-year core inflation, stripping out volatile food and energy prices, actually rose from 3.2% in August to 3.3% last month; economists had been expecting core CPI to hold at 3.2% in September. The Fed will be watching shelter costs, in particular, which rose 0.2% month-over-month—better than the 0.5% rate clocked in August, but still too sticky at 4.9% year-over-year, accounting for nearly two-thirds of the increase in core CPI for September.

Consumers feeling the pain
Headed into a contentious November election in the US, it’s worth thinking not just about how the Fed will interpret these numbers, but how they feel to households facing them on a day-to-day basis. To that end, data from the University of Michigan released at the end of last month showed most consumers continued to feel the pinch of high prices more viscerally than recent BLS reports might suggest. Especially for lower-income households, whose budgets have been most impacted, 2024 has been marked by a sharp rise in expectations for longer-term price increases (see below).

Sticky CPI looms over next FOMC
Of course, nobody on the FOMC is predicting CPI to hit 9% anytime soon—or, if they are, it’s not something they’re willing to admit on the dot plots we’ve seen. But in all seriousness, the recent stickiness in CPI will obviously factor significantly into discussions over the central bank’s policy move in early November. In fact, the same traders who saw nearly 35% probability of another 50-bps cut at the next FOMC at the beginning of October are now pricing in better than 1-in-10 odds of no change at November’s Fed meeting, and see no chance of another half-point cut.

Storms Hit Jobs

September unemployment pops
Stickier inflation could put the Fed in a particularly difficult spot, especially if the labor market continues cooling: conditions that would make it much harder to strike a balance between two sides of the Fed’s mandate. On the face of it, that’s precisely what we saw in separate data released by the Labor Department on Thursday, which showed jobless claims in the prior week surging by 33K to 258K total claims for the week, significantly higher than the 229K claims analysts expected, and the highest number since last August.

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Hurricane effects muddy the waters
So, should we be getting more concerned about a hard landing? It pays to look a little more closely at the numbers. Many of the states in which applications were climbing—Florida, North Carolina, South Carolina, Tennessee—share at least one thing in common: they were also states devastated by Hurricane Helene at the end of September. Past major hurricanes have resulted in discernable blips in jobless claims, though they’ve all been transitory. And because big storms can prevent people from quickly filing claims, the effects could show up for weeks to come.

Natural disaster damages rising
Of course, it’s not just a temporary spike in jobless claims that results when natural disasters like Hurricane Helene strike. The US National Oceanic and Atmospheric Administration (NOAA) tracks dozens of billion-dollar natural disasters that have hit American cities over the last few decades, and plots a worrying trend toward more frequent and more expensive events over the years (see below). Florida got a taste of this dynamic last Wednesday, enduring another big storm, Hurricane Milton, which ripped through the state with 100-mph winds, tornados, and flooding.

Helene and Milton could be costly
While there is heated debate over the potential impact of climate change on the stats above, there can be little disagreement that increased urbanization is putting more of America’s economy at risk when disasters strike. Estimates for the ultimate cost of Hurricane Helene range from $15 billion at the low end (Moody’s Analytics) to $110 billion at the high end (AccuWeather). Likewise, analysts at Jefferies speculated losses from Hurricane Milton could reach into the tens of billions, while Oxford economics cited 2.8% of US GDP as originating in the part of Florida hit by the storm.

ECB Meeting Minutes

Focus on slowing Euro Area growth
Back to monetary policy and inflation, last Thursday brought a glimpse into the minds of central bankers on the other side of the Atlantic, as the ECB released its September policy meeting minutes. That readout reinforced strong market expectations for a 25-bps cut at the bank’s October 17th meeting, with policymakers clearly worried about growth. Such concerns were understandable, with Eurozone PMI figures released at the beginning of October showing Europe in a contraction. Even final services PMI, higher than the preliminary print, notched its worst mark in seven months.

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Another case of sticky inflation
The ECB finds itself in a position similar to, but arguably worse than, the Fed’s. Like Powell and company, the ECB has seen a nice fall in inflation since the 2022 high (see below), but worries that the ‘last mile’ to its 2% target will be bumpy. Even though headline inflation actually did go below the 2% level in September—its lowest reading since April 2021—core CPI has leveled off just under 3%, and services prices are hovering around a 4% year-over-year increase since late last year. That’s the same stickiness we worry about in US inflation data.

Expect ECB to ease, Euro weaker
Unlike the Fed, which tinkers with policy against a backdrop of positively robust economic growth, European policymakers have those concerns about a stalling economy to worry about. Along those lines, we think the ECB is right to worry about a recession, and we see quarter-point cuts at each of its next two meetings. One implication of economic weakness and rate cut expectations is a weaker Euro, additionally weighed down by France’s fiscal woes, which has fallen toward the $1.093 mark in October trading, extending its bearish trend to a two-month low.