Investment Strategy Brief:
Inflation's Inside Story

Below is a transcript of this week’s video.

Hi, this is Jason Pride, Chief of Investment Strategy & Research at Glenmede.

The September Consumer Price Index (CPI) report was far from alarming on the surface, but provided some hints that Fed’s inflation battle may not be finished. Headline CPI was a touch hotter than consensus at 0.4% month-over-month and core CPI was in line with projections at 0.3% month-over-month. Year-over-year inflation in both cases is now near or below 4%, quite a difference from the 2022 highs.

We find that our preferred way to look at inflation is to look at the 3-month change in CPI – it helps remove some of the noise from the 1-month data but also removes some of the base effects that are inherent with annual growth numbers. As it stands now, there has already been a significant moderation in core CPI, shown on the left, which has essentially been near 3% annualized for the last three months. But interestingly, as can be seen on the right, the components appear to be disagreeing a bit with the headline. CPI associated with food & energy is off-the-chart - up over 16%. And even though other good prices are down for the month, providing some disinflation, prices associated with rental costs and core services are running pretty strong.

Headline CPI ran hotter due to still-rising energy prices, which remain a wildcard given their ties to geopolitical conflict. The recent events in Israel have already triggered a 4.5% surge in brent crude prices, reflecting fears over instability near key global energy resources. Any meaningful escalation to drive energy prices up further.

Meanwhile, core services excluding shelter, one of the Fed’s preferred gauges of embedded inflation trends, notched its third consecutive quarter of acceleration, printing at 0.6% month-over-month.

While inflation has moderated considerably from its summer 2022 highs, a complete return to the Fed’s 2% target is proving to be somewhat elusive. According to the Michigan Consumer Survey, consumer expectations for inflation over the next year seem to agree with this trend, painting a pretty good picture for the Fed. But with ongoing pressures on both the non-core inflation through energy prices and core inflation through still-rising services prices, there is little indication that inflation is imminently on a sustainable path toward the Fed’s 2% target for the current 4% run-rate. As if in accordance with this, consumer expectations for inflation over the next 5 years appear a little more stubborn than the shorter-term expectations.

The question will soon become turn to whether the Federal Reserve will patiently wait for inflation to decline the remainder of the way. The Fed appears to be at the stage of fine tuning its policy. If inflation comes in below expectations while continuing to moderate closer to the 2% target, the Fed may be able to back off on its tightening campaign and even consider reducing rates. However, if inflation reaccelerates, it could push the Fed toward additional rate hikes. But what matters most, is the Fed has had to raise rates significantly over the last year and a half, to the point where monetary policy is now quite tight and at levels similar to when it has caused recessions in the past.

So to summarize:

• The September Inflation report was far from alarming on the surface, but provided some hints that Fed’s inflation battle may not be finished
• Some components of inflation have shown signs of reacceleration for multiple months in a row
• A leading driver of inflation has been oil prices, which remains a wild card under current circumstances
• Importantly, core services excluding shelter notched its third straight quarter of incremental acceleration to 0.6% month-over-month
• Heading into year end, one last rate hike remains on the table for the Fed, but with or without this hike, rates are now clearly into restrictive territory

Thanks for listening! And please don’t hesitate to reach out with any questions.