The latest CPI report came in mostly in line with forecasts and was driven by high energy prices.
The CPI numbers
Headline CPI rose 0.4% month over month, matching expectations but up from last month's 0.1%. Year over year, headline CPI came in at 3.4%, in line with expectations and unchanged from the prior month. Inflation is not rising on a yearly basis, though it did rise month over month.
Core CPI, which strips out food and energy, rose 0.3% month over month - a tenth higher than the roughly 0.2% many expected. Year over year, core CPI came in at 2.4%, in line with expectations, a tenth lower than a month ago, and the lowest level in 5 years.
Energy drove the report. Energy rose 2.1%, energy commodities rose 4.2%, fuel oil jumped 10.1%, and gasoline rose 3.9%. Outside energy, the picture was mild. New vehicles rose 0.3%, used cars and trucks rose 0.4%, and apparel was unchanged. Food rose 0.1%, food at home was unchanged, and food away from home rose 0.3%. Rent rose 0.3%, owner's equivalent rent rose about 0.2%, and automobile insurance fell again.
Market reaction
After the print, e-mini futures rallied more than 1%. The 10-year Treasury yield first moved higher, then fell below 4.9%, trading around 4.89% (quoted between 4.91% and 4.92% at one point). Crude oil dropped 3.8%, trading just over $98.50, later down 3.6% at $98.75. The US dollar also fell. The setup is a lower dollar, lower 10-year yields, and lower crude oil - a strong macro backdrop. These 1% up days have been hard to get through August and September, when trading was tepid. Some traders called it a possible "rip your face off" rally.
The rate decision
The Federal Reserve delivers a decision the following Wednesday. Right after the number, the CME Group (CME) FedWatch tool put the odds of a rate hike near 90%, up from about 70% the day before, then eased to 84.7%. When the tool sits near 90%, it signals a hike is coming.
Rising futures might suggest the market reads this as a "one and done" hike. I do not agree. Crude oil was near $80 two weeks ago and now trades around $100 - roughly 25% higher in two weeks. A quarter-point hike in the federal funds rate will do nothing about higher crude prices. With the rest of inflation fairly mild, the case for aggressive tightening is weak. But the market often gets it wrong.
We are in a Fed quiet period, so no Fed speakers can comment unless something leaks, which has happened before. Watch the Wall Street Journal and its associates for any Fed leaks.
Kevin Warsh does not want to raise rates. His focus is housing, the consumer, and small business. That creates tension: the market wants one outcome, and he likely wants another, which makes the next couple of days tricky.
Even so, a hike may be forced for credibility - to answer questions and calm worries about inflation rising. His Jackson Hole speech was read as signaling he would have hiked had the decision fallen that day, and this CPI is the last major data point before the meeting.
Diesel is at all-time highs, hitting the $6 mark, which feeds into transportation, food, and core goods, and can push inflation higher. So the problem is not only oil. A hike that brings down oil might help with those other pressures. On housing, mortgage rates are above 7%, and Warsh does not want to push them higher. That is a double-edged sword.
