US inflation flat at 3.7% in September, but higher than street estimates

13 Oct 2023 , 02:54 PM

US inflation flat, but not satisfactory

The US headline inflation for September was flat but was disappointing. It stayed at 3.7% for September 2023, exactly where it had it had been in August 2023. But that is higher than the Reuters consensus estimate, which had pegged September inflation at around 3.5% for the month of September. Now consumer inflation in the US has been progressively hardening over the last 3 months in a row, and in the process it is up by 70 basis points. More importantly, it also means that the US headline consumer inflation for September is a full 170 bps above the Fed target rate of 2%. It is in this light that the hawkish tone of the Fed becomes relevant, and now the hawks within the Federal Open Markets Committee will have a strong reason to push for a rate hike of 25 bps in the November 01, 2023 Fed meet. Of course, between now and the November Fed policy, the PCE inflation will be put out and so will be the first advance estimate of Q3 GDP in the US. However, inflation staying at 3.7% does make a strong case for the Fed to hike rates in November itself. 

It was only in June 2023 that the US inflation had touched 28-month low of 3%. Since then, the one factor that has driven up inflation in the US is the sharp spike in oil prices. It is a double whammy, which includes the waning of the base effect as well as the recent spike in crude oil prices. The recent geopolitical risks in the Middle East and West Asia, only makes the case stronger for the Fed to hike rates at the November meeting. However, the fact is that most of the pressure continues to come from fuel inflation. For instance, core inflation fell 20 bps to 4.1% while food inflation fell by 60 bps to 3.70%. 

How the September inflation reading will impact Fed stance?

In the latest FOMC meeting in September (based on minutes released in October), there was a clear dichotomy among members who wanted more rate hikes and the members who did not. However, the consensus that emerged was that the rates, even if it is not increased, would be kept at elevated levels for a sufficiently long period of time. In addition, rate cuts would be back-ended just as rate hikes had been front ended by the Fed. That was the gist of the consensus that came out of the Fed decision post the September FOMC meet.

However, what cannot be denied is that the spate of rate hikes by the Fed has certainly helped the US economy contain inflation, notwithstanding the recent vagaries in the inflation number. Despite the bounce in inflation in recent months, the headline inflation is a good 540 basis points below the peak level of inflation at 9.1% scaled in June 2022. That is an achievement in itself. The 525 bps rate hike by the Fed since March 2022 has surely had a deep impact in containing inflation. 

In recent days, experts like Bob Michele, the CIO of JP Morgan Fixed Income Group, have gone to the extent of saying that the Fed may be forced to cut rates by end of 2023 due to recession pressures. It is a tough call, but that looks quite a remote possibility if one looks at the recent data flows on PCE inflation and GDP growth. The Fed appears to have very successfully engineered a soft landing for the US economy. In fact, when the inflation had fallen to 3% in June 2023, the Fed did not immediately relent on its hawkish stance and raised rates even after that. That has given some buffer to the Fed in the current market. 

That brings us to the million dollar question, where does that leave the Fed stance, especially after sticky inflation in September 2023 at 3.70%. If you scratch the surface, it is evident that food and core inflation have continued to fall in the last 3 months and the inflation pressure is only coming from energy prices. That may be temporary, especially in the light of the strength in the dollar. The November 2023 FOMC meet could be touch and go. Even if the Fed does hike rates by 25 bps in November, it will come with an adequate assurance marking the end of the rate hike cycle. 

Static inflation in September, after two monthly spikes

The overall fall in US inflation from the peak in June 2022 is still very impressive at 540 bps in response to a 525 bps spike in interest rates. Inflation is down from 9.1% to 3.7%. Of course, the Fed would still be worried that it now stands a full 170 bps away from its 2% inflation target. However, the Fed would also take consolation from the fact that this is purely driven by oil prices; even as food and core inflation is trending lower. The two recent months of spike in inflation may induce the Fed members to turn hawkish, but with rats well above neutral rates, impact on growth will be a major area of concern.

Since the peak of inflation at 9.2% in June 2022, the glide path was impressive up to June 2023. During this period, the headline consumer inflation fell to 8.5%, 8.4%, 8.2%, 7.7%, 7.1%, 6.5%, 6.4%, 6.0%, 5.0%, 4.9%, 4.0%, and 3.0%; that is a progressive fall in inflation for 12 months in a row. However, this trend got partially arrested with the inflation spiking by 70 bps in July and August 2023 and staying put in September 2023. However, the one factor that would work on the minds of the FOMC members in September is that the higher inflation has been entirely driven by fuel inflation even as food inflation is down by 60 bps over August 2023 and core inflation is down 20 bps.

Food and core inflation lower; energy prices harden again in September

The latest inflation spike, led by fuel prices, raises the spectre of rate hikes once again. November may be a decisive month in terms of the rate decision.

Inflation Basket Category	Sep 2023 (YOY)	Aug 2023 (YOY)	Inflation Basket Category	Sep 2023 (YOY)	Aug 2023 (YOY)
Food Inflation	3.70%	4.30%	Core Inflation	4.10%	4.30%
Food at home	2.40%	3.00%	Commodities less food and energy	0.00%	0.20%
Cereals and bakery products	4.80%	6.00%	Apparel	2.30%	3.10%
Meats, poultry, fish, and eggs	0.20%	0.00%	New vehicles	2.50%	2.90%
Dairy and related products	-0.20%	0.30%	Used cars and trucks	-8.00%	-6.60%
Fruits and vegetables	0.80%	2.10%	Medical care commodities	4.20%	4.50%
Non-alcoholic beverages	4.00%	4.80%	Alcoholic beverages	4.20%	3.70%
Other food at home	4.20%	4.50%	Tobacco and smoking products	5.60%	5.60%
Food away from home	6.00%	6.50%	Services less energy services	5.70%	5.90%
Full service meals and snacks	5.10%	5.20%	Shelter	7.20%	7.30%
Limited service meals	6.40%	6.70%	Rent of primary residence	7.40%	7.80%
Energy Inflation	-0.50%	-3.60%	Owners’ equivalent rent	710%	7.30%
Energy commodities	2.20%	-4.20%	Medical Care Services	-2.60%	-2.10%
Fuel oil	-5.10%	-14.80%	Physician Services	-0.20%	0.30%
Gasoline (all types)	3.00%	-3.30%	Hospital Services	4.50%	3.00%
Energy services	-3.30%	-2.70%	Transport Services	9.10%	10.30%
Electricity	2.60%	2.10%	Motor vehicle Maintenance	10.20%	12.00%
Natural gas (piped)	-19.90%	-16.50%	Motor vehicle insurance	18.90%	19.10%
Headline Consumer Inflation	3.70%	3.70%	Airline Fare	-13.40%	-13.30%

Data Source: US Bureau of Labour Statistics

The above food basket would be key to the decision by the Fed. It now looks like another rate hike of 25 bps this year may still be possible, although the Fed would like to explore all options before taking that decision. There are some encouraging takeaways for the Fed.

• Between July 2023 and September 2023 headline inflation spiked from 3.2% to 3.7%. During this same period, the food inflation is down 120 bps from 4.90% to 3.70% on yoy basis. If you look at the components of the food basket, inflation has fallen across the board on a yoy basis, except in the case of meat and poultry products.

   

• The real action is in the energy basket, although the overall energy inflation is still in negative, it is almost flat now. In fact, between July 2023 and September 2023, the energy has hardened sharply from -12.50% to -0.50%.

   

• Core inflation has eased by 60 bps from 4.70% in July 2023 to 4.10% in September 2023. That is good news as it hints at lower structural inflation in the US economy.

MOM inflation tapers to 0.4% in September 2023

The US Bureau of Labour Statistics (BLS) reports inflation on yoy basis, as well as on MOM high frequency basis. Between July and August 2023, MOM inflation spiked from 0.2% to 0.6% but tapered back to 0.4% in September. Here are key takeaways from the MOM inflation data for September 2023.

1. MOM food inflation in September 2023 rose at a flat 0.2%. A total of 3 out of the 6 store food categories saw higher inflation. Cereals and bakery production fell -0.4%, the first time since Jun 2021.

    

2. Energy index rose a 1.5% MOM in September 2023 as energy commodities like gasoline and natural gas increased sharply in the month. Natural gas is the segment that continues to show negative inflation.

    

3. Core inflation growth was flat at 0.3% MOM in September 2023.  The inflation pressure comes from rentals and motor insurance, whereas the lowering of pressure is due to used cars and medical care 

How will RBI interpret latest US Consumer Inflation reading 

For the RBI, the US consumer inflation will be a key input as it grapples with rising inflation in India also. Indian inflation may have tapered in the last 2 months from 7.44% to 5.02%, but it still remains well above the RBI median inflation target of 4%. For the RBI, it pushes the central bank into a decision making corner. For the RBI, the challenge is not just to manage price stability but also to manage inflation expectations. Indian inflation expectations have been reined in the past, when the RBI has stood up to subdue inflation by making money dearer. The sticky US inflation makes another rate hike very likely when the Fed meets in early November. 

What the RBI would be perfectly wary of is that FPI flows have dwindled after a deluge between May and July. In September FPIs turned net sellers to the tune of $1.78 billion and that trends looks set to continue in October 2023 also. In previous months, we had written about the need for the RBI to have a Plan-B in place. Rising rates in the US amidst low inflation and static rates in India amidst rising inflation; is not a very healthy combination. The RBI is, obviously, conscious that it is being gradually forced into a decision making corner.