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Sticky CPI: A Brewing Storm Outside the Shelter

The only Consumer Price Index (CPI) report before the next Fed meeting was released last week, and unfortunately, it will confuse the Federal Reserve. September CPI was 2.4%, sandwiched between 2.3% expectations and the prior month’s 2.5% inflation rate. Core inflation was the disappointment, moving higher to 3.3% after August’s 3.2% reading. Investors ignored the core data, which pointed to pausing rate cuts. The consensus held steady that the Fed would cut rates 25 basis points at their November meeting. The Atlanta Fed’s Sticky-Price CPI gauge supported the consensus because it dropped from August’s 4.1% inflation rate to 4.0% in September. That was the lowest level this year and the lowest reading since January 2022.

This drop is important for the Fed because Sticky-Price CPI contains valuable information about future inflation. Those who set prices of items that do not change often try to carefully account for inflation over those longer periods. That means the drop in Sticky-Price CPI, down 0.6% since the end of 2023, reflects lower inflation expectations and points to lower future inflation.

But there is a catch. While housing-related inflation and core services continue to wind down, core services' ex-shelter inflation refuses to decline. The Federal Open Market Committee (FOMC) places a great deal of weight on core services ex-shelter data. Big items in that important inflation metric, such as Medical Services, Auto Insurance, Car and Truck Rental, and even Tuition and Childcare, all rose in September. Therefore, given these crosscurrents, we were not surprised when Atlanta Fed President and FOMC voter Raphael Bostic said after the CPI number that he is “definitely open” to skipping a rate cut at the November meeting, preferring to wait for better visibility. The Fed may try to steer investors toward a “no rate cut” consensus in the coming weeks, which would weigh on equities and commodities.

The Country is Voting for Inflation

The country finally found something to agree on, but economically speaking, it is not good news. The University of Michigan asked consumers where they stood on trade and immigration,  specifically whether increased immigration and more trade with other countries is favorable for the U.S. economy. While there were differences in responses based on age, education, income level, and party there was an overall shift, as the country views both topics more negatively. Those who are advocates for expanding trade fell from almost 70% to just over 50% over the past four years. In 2020, more people favored increased immigration, but now only one in four equate greater immigration with increased economic activity.

This is an unfavorable shift that will depress growth and raise prices. Politicians of both parties will be more open to laws restricting trade and increasing tariffs. They will also be aware of the shift among their constituencies over immigration, making them vote for stricter immigration. In the same way that E=mc² is universally accepted, economic growth equals productivity + labor force growth. Given U.S. demographics, we need immigration flows to expand our workforce; otherwise, we are entirely dependent on productivity growth to drive economic expansion. With less immigration, wages will increase because businesses will be competing to employ workers from a smaller labor pool. Higher wages puts upward pressure on services inflation. Contracting globalization and increased tariffs can only push goods inflation one way—up. Expect more stagflationary headwinds for the economy out of Washington until general opinions change.

Illusion of Consent

Nineteen years is a charm. Michelle Bowman was the first Fed Governor to dissent at a Federal Open Market Committee (FOMC) meeting since 2005. Fed governors rarely dissent (There were two minor dissents from two Fed regional presidents when the Fed started its rate-hiking campaign in 2022). Since then, there have been no dissenting votes. Fed Chairman Jerome Powell has prided himself on this unanimity, often describing the Fed as a consensus-driven organization.

But is it?

The July 2024 FOMC meeting minutes noted that all participants supported keeping the target rate unchanged, yet “several observed…a plausible case for reducing the target range 25 basis points at this meeting or that they could have supported such a decision.” Not a resounding case for consensus. Notably, the latest September FOMC meeting minutes mentioned that  “some participants noted they would have preferred a 25-basis point cut at September’s meeting [as opposed to the 50-basis point rate cut decision].”  

To be clear, there are 19 participants, and only 8 are permanent voters: the Fed Chair and Vice-Chair, and the President of the New York Fed, and 5 Governors. The other 11 regional Fed Presidents rotate yearly to fill the other 4 seats. Therefore, it is possible that there truly is a strong consensus among the voters except for Governor Bowman and all the dissenting views are held by non-voters. Regardless, we believe the Powell Fed has lost a great deal of credibility due to their reluctance to raise rates before March 2022 and now, based on their new rate-cutting stance. These inconsistencies bubbling up in the last two meeting minutes only strengthen our conviction. We think the consensus will move toward our view that the Fed needs to manage rates better, which is a market negative.

What to Look for This Week

1. Tuesday, October 15 at 5:00 a.m. E.D.T. October ZEW Economic Sentiment for the Eurozone and Germany. Focusing on Germany’s six-month economic outlook specifically because it has fallen from 47.5 in June to 3.6 in September. A negative reading spells recession and could bolster the consensus that the European Central Bank (ECB) will cut 25 basis points. This would put more upward pressure on the U.S. Dollar, which rallied almost 3% during October.

2. Thursday, October 17 at 8:15 a.m. E.D.T., the European Central Bank announces its interest rate decision. They have guided expectations toward a 25-basis point cut. ECB President Christine Lagarde holds her press conference half an hour afterwards and may contain some hints about where the central bank is leaning for their next rate decision on December 12.

3. Friday October 18 at 8:30 a.m. E.D.T. U.S. Building Permits for September. August’s reading was the highest since April, and September will be critical to see if there will be another improvement because mortgages became more expensive when rates rose in the back half of September. Longer term interest rates increased even though the Fed cut short-term interest rates on September 18. 

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