The increase in core inflation was primarily driven by higher rental costs, which rose 0.7%m/m, utility costs, which rose 1.5%, and new car prices, which rose 0.8%. Food prices, meanwhile, rose 0.8% mom. Strength in these components thus largely outweighed weakness in gasoline prices, which fell just over 10%m/m in August.
“The slowness of primary rents and OER in the CPI data suggests that housing construction will continue to provide a sizeable boost to core inflation in the coming months,” note analysts at Well Fargo. “At the same time, price growth for other services such as medical, insurance, college tuition and personal care continues to advance at a strong pace, underscoring the continued sluggishness of inflation,” they add.
Markets up Fed tightens bets
In response to the much hotter than expected August core US inflation data, markets have reacted by significantly increasing their bets on Fed tightening in the coming quarters. While the Fed Funds futures markets were priced in just below 3.8% year-end ahead of Tuesday’s data for US benchmark interest rates, they are now priced about 25 basis points higher in the 4.0% range for year-end.
While Fed fund futures markets were primed for benchmark rates to peak at around 4.0% next year, rates will now be around 4.25% through the end of the first quarter.
In terms of upcoming Fed meetings, according to the CME’s FedWatch tool, where US money market prices are showing a 91% chance of a 75 basis point rate hike and a slim 9.0% chance of a smaller 50 basis point rate hike implied at next week’s FOMC meeting that a hike of at least 75 basis points is now considered certain, while the probability of an even larger 100 basis point rate hike is priced in at around 18%.
Most analysts are sticking to their calls for the Fed to press ahead with a 75 basis point rate hike next week, regardless of the latest CPI read. However, many are now calling for a further 75 basis point rate hike at the November meeting, with money markets also implying that this is now the base case.
According to the CME’s Fed Watch Tool, there is now a 51.4% chance that the Fed will cut rates to the 3.75-4.0% range (150 basis points above the current 2.25-2.0% level) by the November meeting .5%) versus just a 14.1% probability at the price a day ago.
The latest inflation numbers will alarm the Fed, which has already raised concerns about the prospect that core price pressures will remain elevated. As such, the market reaction likely makes sense – if core inflation is more persistent than previously thought, the Fed is likely to respond with additional tightening.
In terms of market reaction; Unsurprisingly, US stocks have come under pressure as valuations take a hit amid higher interest rate prospects while crypto has also been hit. The US dollar has rallied, as have US yields along the curve, while gold was hit.
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