US: Inflation slows more than predicted, giving Fed room to downshift

In the US, the consumer price index rose 7.7% year-on-year, registering the smallest annual increase since the beginning of the year, falling from 8.2% in September. Core prices, which exclude food and energy and are considered a better baseline indicator of inflation, rose 6.3% in the previous month, falling from a 40-year high. The core consumer price index increased 0.3% month-on-month, while overall CPI increased 0.4%. Both yearly and monthly gains fell short of median economist estimates (expected: 0.6% headline and 0.5% core). Thus, US inflation cooled more than forecast in October, giving hope that the fastest price increases in decades have receded. That gave Fed officials room to slow down steep rate hikes.

If we look at the sub-items; Declines in price indicators for medical care services and used vehicles limited the core indicator. Higher shelter costs contributed to more than half of the overall CPI increase. Housing costs, the largest services component and accounting for about a third of the overall CPI index, rose 0.8% last month to the highest level since 1990. The rent index rose 0.7% during the month, and the owners' equivalent rent index (OER) rose 0.6%. While private sector data indicate a stabilization or even decline in rents in various cities across the country, there is a lag between real-time changes and when they are reflected in Department of Labor data.

The narrow CPI, which excludes food, energy and shelter, fell 0.1%, the weakest reading since May 2020. Food costs slowed, rising 0.6% in October after rising 0.8% in September. The clothing index decreased by 0.7% compared to the previous month. In October, the new vehicles index increased by 0.4% and the personal care index increased by 0.5%. Used car prices, on the other hand, fell 2.4% as demand collapsed. Gasoline prices rose 4%. The airline tickets index fell 1.1% in October after rising 0.8% in September. Here, of course, the cost effect of the situation in oil prices is an item that can be very variable. Health insurance costs also fell by a record 4%, leading to the sharpest decline in general medical care services since 1971.

12-month percentage change, Consumer Price Index, selected categories, October 2022, non-seasonally adjusted… Source: U.S. Bureau of Labor Statistics

Inflation will have a nice seasonality and base effect. Of course, the decreasing demand will be extra important here, especially in terms of the return of services inflation, which currently includes more than half of the inflation structure. However, November sales and Christmas retail sales could still cause a surge. We have been in a more comfortable phase regarding commodity inflation for a while. This is of course good for goods based on external costs and especially energy-intensive raw materials, but it is not disinflation within the policy control area. We will see that the Fed's policies work with the permanent decline or loss of momentum in the inflation of services, not goods. There is still a way to go.

High inflation continues to put pressure on households and broader economic groups. High prices have eaten up wage increases, causing many to tighten their belts or rely on savings and credit cards to keep up their spending. Inflation and the broader performance of the economy also played a role in Tuesday's midterm elections, but exit polls have proven social issues to be a larger factor than pre-election polls suggest. As of Thursday, the results are not conclusive, but it has emerged that Republicans will get a narrow majority in the House of Representatives.

If we look at the Fed's point of view; While the slowdown in core prices is good news, inflation is still far from the Fed's comfort zone. At the FOMC, Powell said interest rates are likely to rise higher than policy makers had previously predicted. Swap traders approached pricing with a half-point Fed increase in December instead of 75 basis points, and where they saw the top rate coming next year (terminal rate) fell below 5% again. There is still uncertainty as to whether the Fed will stop the rate hikes in the 4.5-5% band or above, as dynamic data is taken into account. As a result, Fed rates are still not at a level to fully beat inflation, and signs of reaching the 2% target are still at a distant level.

Inflation affects economies globally, prompting the world's most aggressive and synchronized monetary policy to tighten in the last 40 years, and raising the risk of a global stagflation. Fed officials will have both another CPI report and an employment report before the end of the two-day policy meeting in mid-December. While the Fed launched the most aggressive tightening campaign since the 1980s, labor market and consumer demand has largely made many sticky items resilience. But the housing market, for example, deteriorated rapidly due to rising mortgage rates. While the Fed's path back to its inflation target is expected to involve an increase in both recession and unemployment, consumer price growth is expected to be even more moderate next year.

Kaynak: Tera Yatırım-Enver Erkan
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