US CPI Data Signals Potential 25 BPS Fed Rate Cut in December, Says Macquarie

A Closer Look at CPI and the Case for a December Rate Cut

As economic observers and analysts digest recent consumer price index (CPI) data, many anticipate that these numbers are paving the way for a 25-basis-point interest rate cut in December. Bernstein economists David Doyle and Chinara Azizova have noted that the data aligns with their expectation for a modest rate reduction, citing that inflation, though slightly increased in October, remains on a stable path that supports this policy move.

The October inflation report from the Bureau of Labor Statistics highlights the CPI as a reliable gauge of consumer costs, spanning a broad spectrum of goods and services. According to the report, the CPI rose by 0.2% for the month, elevating the annual inflation rate from 2.4% in September to 2.6% in October. Importantly, both figures aligned with Wall Street forecasts, as projected by Dow Jones analysts, supporting the argument for a rate cut as the Federal Reserve seeks to sustain economic growth.

Core Inflation Trends: Stability Amid Shifting Prices

Beyond the overall CPI, core inflation trends offer a nuanced view of consumer price stability. Core CPI, which omits food and energy costs to provide a clearer picture of underlying inflation, rose 0.28% in October. This increase translates to a 3.3% annual rate, slightly softened from September’s data. These figures support Bernstein’s economists’ view that the core personal consumption expenditures (PCE) measure—a closely watched inflation indicator for the Federal Reserve—will likely exhibit more softness in upcoming readings, particularly given favorable base effects heading into the first quarter of 2024.

Within core CPI, distinct patterns emerged across various categories. Core goods prices remained stable on a month-to-month basis, but used car and truck prices stood out with a notable increase. Meanwhile, core services, excluding rent and owners’ equivalent rent (OER), slowed slightly, registering a 0.3% monthly increase, which economists attribute to a decline in airline fares. This moderation in core services is particularly relevant for inflation watchers, as it may signal a broader stabilization of inflation in key service sectors.

The Housing Factor: Rent and OER Trends

Housing remains a significant component of inflation metrics, especially within core CPI. Rent and owners’ equivalent rent—essential elements of the core inflation calculation—showed some acceleration in October. Specifically, OER rose 0.4% for the month, while the rent of primary residence edged up by 0.3%. Though these figures suggest mild increases, both rent and OER are currently on broader downward trends, offering hope for continued moderation in housing-related inflation as we move toward 2024.

Bernstein’s team remains optimistic that core inflation will continue to moderate, thanks largely to these favorable housing trends. However, they caution that potential trade policy changes, such as new tariffs, could introduce an upside risk to inflation in the medium term.

Stock Market and Treasury Yield Reactions to CPI Data

The inflation report also had immediate implications for financial markets. Stock market futures rose slightly following the CPI data release, indicating optimism among traders regarding the Federal Reserve’s next moves. Meanwhile, Treasury yields decreased as investors adjusted their expectations for the December policy meeting. With the data providing further evidence of inflation stabilizing, market participants have now raised their bets on a quarter-point rate cut.

The market reaction underscores the cautious optimism among investors and analysts who see a moderate rate cut as a supportive measure to keep the economy on a stable path. As inflation continues to hover within manageable limits, the likelihood of a December rate cut has grown, providing a more predictable outlook for market participants and reinforcing a favorable investment climate as 2023 draws to a close.

The Road Ahead: Inflation Outlook and Potential Challenges

As we look forward, Bernstein economists project that core inflation will likely soften in the coming months, largely due to base effects from earlier inflation peaks that should favor lower readings. These base effects are expected to have a significant impact in the first quarter of 2024, potentially helping to maintain core inflation at manageable levels. This outlook aligns with the Federal Reserve’s aim to manage inflation while avoiding overly restrictive policies that could stifle growth.

Nevertheless, several factors could still influence the inflationary landscape. One such consideration is the possibility of new tariffs, which could drive up costs for consumers and businesses alike. If implemented, these tariffs might exert upward pressure on inflation, complicating the Federal Reserve’s balancing act. Additionally, fluctuations in energy prices or other unforeseen economic shocks could introduce volatility, although these risks currently remain at manageable levels.

Bernstein’s Perspective: Favorable Conditions for a December Rate Cut

In light of the October CPI data and current economic conditions, Bernstein economists Doyle and Azizova remain confident in their outlook for a 25-basis-point rate cut in December. Their stance reflects a broader consensus that inflation is stabilizing and that a modest rate reduction would provide a helpful stimulus as the economy enters the new year. This perspective is supported by the alignment of October’s inflation figures with Wall Street forecasts, indicating that the Federal Reserve has a window of opportunity to adjust rates without inciting market disruption.

Their comments also reflect a careful watch on core PCE readings, as this index has tended to show more moderate inflationary trends than core CPI. If core PCE readings continue to remain soft, it would further support the case for a gradual reduction in interest rates, keeping inflation in check while fostering economic growth.

Conclusion: Anticipating a Moderate Rate Adjustment as Inflation Trends Hold Steady

The October CPI data has reinforced expectations for a gradual easing of inflation in the months ahead, with the Federal Reserve potentially responding with a 25-basis-point rate cut in December. Bernstein’s team underscores that current inflation dynamics are conducive to this policy shift, with core inflation stabilizing and favorable base effects likely to moderate inflation into early 2024. However, potential trade policy adjustments and economic shocks could still alter the landscape, underscoring the importance of monitoring these factors closely.

For investors, the prospect of a rate cut suggests an easing in borrowing costs and a generally favorable environment for equities and bonds. With inflation appearing under control, the Federal Reserve has an opportunity to support continued economic stability, paving the way for a cautiously optimistic outlook as we move into the next year.