October inflation data this week show little progress toward the Fed’s two percent inflation target, raising questions about how deeply the Federal Reserve will cut rates in 2025.
On Wednesday, the ‘core’ consumer price index (CPI), which excludes the more volatile costs of food and gas, showed prices rose 3.3% in October for the third month in a row. On Thursday, the ‘core’ Producer Price Index (PPI) showed prices rose 3.1% in October, up from 2.8% the month before and above economists’ expectations for a 3% increase.
Taken together, the measurements contribute to an overall picture of persistent, persistent inflation within the economy. Economists don’t see the data changing the Fed’s outlook in December. And markets agree that the CME FedWatch Tool currently offers a nearly 80% chance that the Fed will cut rates by 25 basis points at its December meeting.
But the lack of recent progress on inflation could prompt the Fed to adjust its Summary of Economic Projections (SEP), which forecast the central bank would cut rates four times by 2025, or a total by one percentage point.
“PPI will not decisively change the Fed’s dovish bias, but it does make the mapping of the policy outlook more unclear,” national financial markets economist Oren Klachkin wrote in a note to clients today. ‘We expect 75 [basis points] of cumulative Fed easing through 2025, but risks appear to be shifting to a more gradual pace of easing.”
“Their preference is to cut spending, but next year they will probably have to do it at a slower pace,” Stephanie Roth, chief economist at Wolfe Research, told Yahoo Finance (video above).
The markets have moved rapidly over the past two months to reflect this sentiment. On September 18, when the Fed cut rates by half a percentage point, markets had forecast that the Fed would end 2025 with a federal funds rate around 3%. Now the market is pricing in about 80 basis points less easing next year.
This speculation has also led to a large increase in bond yields over the past month. Ten-year Treasury yields (^TNX) have risen about 80 basis points since the Fed’s first rate cut in September. But that in itself hasn’t proven to be a headwind for the stock market rally, as all three indexes are within striking distance of new all-time highs. Investors have attributed the market’s resilience to stronger-than-expected economic data pouring in as bond yields rise.
“The reason it hasn’t hit the stock market is very simply because if interest rates rise, in part because growth will be stronger, that effect will be stronger in the stock market,” said co-chief investment officer of Bridgewater Associates. Karen Karniol-Tambour said at the Yahoo Finance Invest conference.
At his most recent press conference on November 7, Fed Chairman Jerome Powell said inflation continues to decline on a “bumpy path,” but declined to provide further guidance on the Fed’s path.
“We don’t know the right pace and we don’t know exactly where the destination is [of rates] is,” Powell said. “So it’s about finding that, finding the right pace and the right destination along the way. And I think there’s quite a bit of uncertainty about that. “
But economists are taking hints from recent trends in inflation rates. Three-month core annualized inflation rose to 3.6% from 3.1% last month after the October CPI release. This underlines the recent lack of progress toward the Fed’s 2% target. Add to that the potentially inflationary economic policies expected from newly elected President Donald Trump, and the picture becomes even more uncertain.
“Inflation data in recent months has not shown much additional progress, and the election results have raised new questions about the future path for price growth,” Wells Fargo senior economist Sarah House wrote in a note to clients. “We believe the time is fast approaching when the FOMC will signal that the pace of rate cuts will slow further, perhaps to a pace that will follow every other meeting from 2025.”
Economists use the CPI and PPI data to provide an indication of the “core” Personal Consumption Expenditures (PCE) index, the Fed’s preferred inflation gauge. Bank of America economist Stephen Juneau thinks core prices will rise 2.8% in October, compared with 2.7% in September.
“If our forecast proves correct, this will mean two consecutive uncomfortable high pressures as the Fed strives to return inflation to its 2% target,” Juneau wrote in a note to clients on Thursday.
He added that this does not mean markets should “panic.” Some of the factors that pushed inflation higher in October, such as financial services and airline tickets, are not expected to hold. Moreover, inflation expectations remain low and the labor market no longer appears to be a source of inflation concern.
Still, Juneau, like other economists, argues that recent data shows “risk appears to be shifting toward a shallower austerity cycle, given resilient economies.” [economic] activity and persistent inflation.”
Josh Schafer is a reporter for Yahoo Finance. Follow him on X @_joshschafer.
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