Federal Reserve on Track

The Consumer Price Index (CPI) rose at a 2.5% year-on-year pace in October, with almost a third of those gains driven by an increase in prices at the gas pump. The less volatile and more critical core CPI (excluding food and energy) rose a more tepid 2.1% from a year ago. Shelter costs slowed after being a major contributor to gains this year. That reflects the recent slowdown we have seen in the housing market, especially in what were the hottest urban markets.

Food prices declined slightly in October, particularly food consumed at home. Prices fell for fruit & vegetables, dairy and cereals and bakery items. Prices for meat, poultry, fish and eggs were flat.

We expect inflation to slow again in November as falling prices at the pump leave more discretionary dollars in consumers’ wallets just prior to the holiday season. Shelter costs are expected to cool further. Demand has softened as foreign buyers have pulled back. The ongoing fly in the ointment is medical costs, which along with other service sector costs are expected to pick up in the months to come.

Another potential problem for inflation is tariffs. The administration has revealed deep divisions among its economic advisors on this issue. The director of the National Economic Council (NEC), Larry Kudlow, is working to tamp down threats of additional tariffs on China at the same time that Peter Navarro, the director of trade policy, has escalated his rhetoric. The administration is threatening to levy tariffs on vehicles, which had received a waiver at least temporarily.

This is all in addition to the inflation that is already in the pipeline. Retailers and manufacturers have attempted to absorb the shock due to higher input prices created by tariffs. However, across-the-board prices are slated to go through at the start of the new year.

Bottom Line
The Federal Reserve is still on track to raise rates in December. The trajectory of additional rate hikes will depend on how sustained an increase in inflation at the start of the year will be.

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