The consumer price data for October came in as expected, with overall prices rising 0.2% m/m and core prices (ex food and energy) up 0.3% m/m. This lifted the headline inflation rate by two tenths to 2.6% y/y while leaving the core inflation rate unchanged at 3.3% y/y. Both the consumer price as well as the producer and import price data remain consistent with another rate cut in December. The market pricing for a December cut has oscillated widely, up to about 80% in the aftermath of the CPI data and then down to about 60% following Friday’s retail sales data.
Truth be told, the US inflation data remains mixed. There is something in there for those worried about a potential reacceleration, just as there is plenty for those who share our view that the broad disinflation trend of the past two years has further to run. The big elephant in the room remains shelter, which accounts for over a third of the CPI basket. Housing overall (including fuel, utilities, etc.) is 45% of the basket. Excluding shelter, CPI inflation is running well below 2.0%, just as it did prior to Covid (Figure 1, page 3).
Core goods inflation is in deeper negative territory than had been the case pre-Covid. We anticipate shelter inflation will continue to moderate (market rent data suggest so) whereas goods deflation abates. Whether today’s goods deflation turns to outright inflation in 2025 will depend on the extent and magnitude of tariffs. Earlier tariffs in 2018 did not have that effect, but they were much more targeted in nature relative to what is being considered this time around. Still, there is an argument to be made that as global supply chains continue to heal from Covid disruptions, some degree of price normalization could still be in the cards. Furthermore, a stronger dollar could further diminish the inflationary impact of higher tariffs.
Ultimately, it will be shelter and services, i.e., domestically driven inflation, that will determine the behavior of overall inflation in 2005 and beyond. Shelter inflation was steady at 4.9% y/y in October, having eased from 6.1% in January 2024 and a peak of 8.2% in March 2023. We believe it can ease another full percentage point by mid-2025. Pockets of acute services inflation remain, with car insurance a sore case in point. Motor vehicle insurance costs were 14.0% higher y/y in October, although that was the lowest in nearly two years and down substantially from April’s 22.6% y/y peak. Further considerable moderation is expected here as well, reflecting slower increases in underlying costs (both new and used car prices have actually declined over the past year) and the fact that the premium catch-up process is already well advanced. Transportation services prices also remain elevated at 8.2% y/y. While off post-pandemic highs, there has been little normalization here so far. We suspect a lot more will occur over the next year.
All in all, this leaves our inflation forecast a little higher than where it stood a couple of months ago, yet not materially so. Our call for further Fed rate cuts, including one in December, remains to a large extent a “level” argument. We see core CPI and core PCE easing to 2.5% and 2.3% y/y, respectively, in Q2 2025, so even the current 4.75% Fed Funds rate appears unnecessarily restrictive. Following a December cut, we see the Fed easing an additional 75 bp in 2025.
