Investing - Adobe

Nasdaq Macro+

Core Inflation Keeps Falling

Even though headline inflation increased this week, Core inflation continues to fall

Wednesday morning we got the August inflation (CPI) numbers – a key report before next week’s Fed rate decision.

Headline inflation rose again in August, reaching 3.7% YoY (orange line). However, core inflation (which excludes food and energy) kept slowing to 4.3% YoY (chart below, blue line). That’s good news for the Fed, who was concerned persistently high core inflation might still cause a wage-price spiral.

Headline and Core inflation

Headline inflation affected by oil prices

A smaller negative contribution from energy (left chart, black bars) largely drove the upticks in headline inflation the last couple months because oil prices are up over 30% since late June (you might have noticed prices at the pump rising… right chart). Halfway through September, it looks like oil prices will add to headline inflation again.

Contributions to headline CPI

Oil prices are up – not only because spending and economic growth has kept demand solid – but also because supply remains tight after Saudia Arabia and Russia recently extended their summer production cuts of 1.3 million barrels per day through the end of the year.

However, this was known, so markets were prepared for an energy-driven increase in headline inflation.

Core inflation mostly held up by housing

Core inflation – which has recently attracted the most attention because it’s a better guide to where inflation is headed – fell further. That continues the trends we’ve seen in recent months.

Improving new car inventory helped lower car prices, helped bring core goods inflation is down to just 0.2% YoY (grey and black bars).

Even core services excluding housing inflation is down to 4% YoY (from a peak of 6.5%, blue bars). That’s in large part because wage growth has slowed along with the cooling labor market.

Contributions to core CPI

It’s mainly housing inflation that remains stubbornly high (purple bars).

In fact, core inflation ex housing (navy line) is almost back to the Fed’s 2% target, while shelter inflation remains above 7% YoY (purple line).

Core CPI still on disinflation path

Shelter disinflation should come soon

Even though shelter inflation is still (too) high, it’s actually slowed for five straight months (chart below, purple line).

And Zillow suggests we can expect (much) more shelter disinflation from here. Research shows that housing inflation lags market measures by about a year and their observed rent inflation (a measure of newly-signed leases nationwide) has been in a downturn for 18 months.

In fact, it’s now below pre-pandemic rates (blue line), so we should expect shelter inflation to keep falling from here (for a while), helping bring down core inflation.

Housing inflation

Inflation data confirmed market expectations, leaving markets little changed

Despite clear signs that core inflation is trending lower, with more disinflation to come, the inflation data had little impact on markets. The major equity indices and 10-year Treasury rates are close to flat for the day.

That’s because today’s data pretty much matched what markets had already priced in – and employment is still very strong.

Given that, the markets still expect the Fed to keep rates unchanged next week, but a hike at the November or December meeting is still priced around a 45% chance.

Fed Funds rate chart

However, if core inflation keeps falling (as expected) and the labor market keeps cooling, it will be hard for the Fed to justify another rate hike. Then, the focus could instead turn to when the Fed begins cutting. Currently, markets expect the first cut next summer (orange line).

That will give markets something to react (positively) to.

The information contained above is provided for informational and educational purposes only, and nothing contained herein should be construed as investment advice, either on behalf of a particular security or an overall investment strategy. Neither Nasdaq, Inc. nor any of its affiliates makes any recommendation to buy or sell any security or any representation about the financial condition of any company. Statements regarding Nasdaq-listed companies or Nasdaq proprietary indexes are not guarantees of future performance. Actual results may differ materially from those expressed or implied. Past performance is not indicative of future results. Investors should undertake their own due diligence and carefully evaluate companies before investing. ADVICE FROM A SECURITIES PROFESSIONAL IS STRONGLY ADVISED. © 2023. Nasdaq, Inc. All Rights Reserved.

Subscribe to Nasdaq+ for full access.

Exclusive content, detailed data sets, and best-in-class trade insights to rewrite your portfolio for tomorrow.

Try Now ->