Does incoming data signal another rate increase by year end?

With two FOMC meetings before year end, investors and policymakers are closely monitoring the totality of incoming data to determine whether the committee will lift rates again or go on an extended pause.

The September CPI report was generally in-line with consensus; the headline reading came in at 0.4% month-over-month, slightly above consensus of 0.3% while the core reading printed 0.3% m/m, in line with expectations. As a result, year-over-year headline inflation held steady at 3.7% while core inflation eased further from 4.3% in August to 4.1% last month. While the print was generally close to forecasts, market reaction suggests inflation data remain elevated. Stocks sold off and yields rose after the release, with particular pain being felt in long bonds.

With two FOMC meetings before year end, investors and policymakers are closely monitoring the totality of incoming data to determine whether the committee will lift rates again or go on an extended pause. Given recent data has remained resilient, investors should not rule out another hike. Notably, 3Q23 real GDP growth is now tracking 4%; revisions to payroll numbers hint at a reacceleration in job growth with the 3-month moving average jumping from 150K to 266K; and the Fed’s preferred “super core index” (core services ex. shelter inflation) jumped 0.6% last month.

In addition, base effects are having an impact on inflation readings given the volatility in price changes last year. Year-over-year inflation is a function of how the monthly inflation readings compare to the same month in the prior year.  Given prices accelerated in 1H22, the march lower in y/y inflation readings for the first half of this year were supported by base effects. In our view, disinflationary base effects through 1H23 are likely to reverse leading to base effects lifting year-ago comparisons for the remainder of the year. Perhaps looking at near term inflation momentum on a 3- or 6-month annualized rate would be more appropriate and suggests a more sanguine inflation backdrop. Indeed, the 3-month and 6-month annualized rate of change for core CPI are at 3.1% and 3.6%, respectively.

All things considered, while recent Fed speech suggests a more dovish stance, 12 of 19 FOMC members see another rate increase and most committee members see inflation as skewed to the upside. Moreover, markets are now pricing in an elevated chance of another rate increase by year end. Given this, investors would be wise to proceed with caution until there is further clarity on when this tightening cycle will end. 

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