With the economy seemingly on track for the mythical “soft landing,” it’s interesting to consider what would be the Fed’s worst nightmare. Given their dual mandate of stable prices and maximum employment, one could very simply say the worst-case scenario is rising prices and a deteriorating jobs market. And while we are nowhere near that at the moment, it is highly likely that the economic indicators released this week will give the Fed something more to consider. Let’s take a look.
Core CPI moved in the wrong direction.
While the Federal Reserve’s attention has switched to labor markets, today’s inflation data was stronger than expected. Core prices rose 0.3% MoM (3.8% annualized) compared to 0.2% MoM expected. On the positive side, rent inflation resumed its deceleration after spiking in August. On the negative side, core CPI excluding rent accelerated to 2.1% annualized, the fastest pace since April 2023. Much of the uptick came from services, even after stripping out volatile pandemic-related services, rent, and energy.
Beyond core CPI, headline inflation was largely in line with expectations. Energy inflation continues to benefit from low oil prices (surprising given the tensions in the Middle East), which is reflected in total CPI, contributing a 0.5% benefit to overall inflation. Said another way, if energy prices were stable year-over-year, headline CPI would have been 2.9% instead of 2.4%. That’s a big difference.
So what does this mean? In a vacuum, it reduces the odds of another jumbo 50 basis point cut going forward. In fact, the probability of a larger cut at the November Fed meeting now sits at zero. But could anything change this?
Was it Helene or something more?
In addition to the hotter-than-expected inflation numbers, we also had a surprisingly impactful weekly initial jobless claims report. The labor data was a sizeable reversal from the recent trend, as initial claims rose to 258K for the week ending October 5th. The consensus expectation was 230K new claims after only 225K the week prior. Not only was this week significantly higher than both, it was the highest weekly level in almost a year and a half.
Now, we know that a large portion of the increase was due to the impact of Hurricane Helene. Claims in Florida, South Carolina, North Carolina, Tennessee, and Kentucky increased considerably. In N.C. alone, claims were up 290% week-over-week. And if there is a silver lining in the numbers, when you exclude these hurricane-impacted states, claims would not be at the highs from earlier last year.
So is the Fed about to have a nightmare?
In short, no, they’re likely to be still sleeping soundly, uninterrupted by bad dreams. Nevertheless, it should be clear that neither report this week was what the Fed would have been looking for. Higher inflation and more jobless claims are a recipe for economists’ least favorite thing: stagflation (high inflation and stagnant economic growth).
Let’s be clear, though, that these two reports do not mean we’re in for doom and gloom. One report does not make a trend; we know that. At the same time, it will undoubtedly catch the attention of the Fed as they navigate upcoming rate decisions in November and December. And with the next big jobs report coming just days before the election, it will be fascinating to watch.
Economy
- Markets were choppy again this week as economic news continued to bounce stocks in both directions. The S&P was up 1.1%, the Nasdaq was up 1.1%, and the small-cap Russell 2000 was up 1.0%.
- CPI increased 0.2% MoM in September, the same as in the previous two months, but above forecasts of 0.1%. The index for shelter rose 0.2%, and the index for food increased 0.4%.
- Core CPI rose by 0.3% from the previous month, picking up from the 0.2% increase in the prior month. Costs accelerated sharply for transportation services (1.4% vs 0.9%).
- Preliminary estimates showed that the University of Michigan consumer sentiment for the U.S. declined to 68.9 in October from a five-month high of 70.1 in September and below forecasts of 70.8. Both the current conditions gauge (62.7 vs. 63.3) and the expectations gauge (72.9 vs. 74.4) weakened.
Stocks
- U.S. equities were in positive territory. Technology and Industrials were the top performers, while Utilities and Consumer Discretionary lagged. Growth stocks led value stocks, and large caps beat small caps.
- International equities closed lower for the week. Developed markets fared better than emerging markets.
Bonds
- The 10-year Treasury bond yield increased nine basis points to 4.07% during the week.
- U.S. bond markets were in negative territory this week, while International bond markets were positive.
- High-yield bonds led for the week, followed by corporate and government bonds.
