Inflation Moderates, but Core Prices Remain Stubborn

The latest inflation data from the Bureau of Labor Statistics has revealed a mixed picture, with consumer prices ticking lower on an annual basis in September, but "core" prices remaining sticky. The report has sparked concerns about the potential for a mild form of stagflation to take hold, as the Federal Reserve navigates the delicate balance between controlling inflation and supporting the labor market.

Uncovering the Nuances of the Inflation Landscape

Headline Inflation Eases, but Core Prices Persist

The Consumer Price Index (CPI) increased 2.4% over the prior year in September, a slight deceleration compared to August's 2.5% annual gain in prices. This annual increase, the lowest since February 2021, came in hotter than economist expectations of a 2.3% annual increase. On a monthly basis, the index rose 0.2%, matching the increase seen in August and exceeding economist estimates of a 0.1% uptick.However, the "core" CPI, which strips out the more volatile costs of food and gas, painted a different picture. Prices in September climbed 0.3% over the prior month, stronger than the 0.2% uptick economists had expected, and 3.3% over the previous year. This marked a slight acceleration from the 3.2% annual increase seen in August.

Shelter and Food Costs Remain Stubborn

The stickiness of core inflation can be largely attributed to the persistent rise in shelter and food costs. The shelter index, which accounts for a significant portion of the CPI, rose 4.9% on an unadjusted, annual basis, a deceleration from August's 5.2% increase. However, the index still rose 0.2% month over month, indicating that shelter costs remain a significant driver of overall inflation.Similarly, the food index increased 2.3% in September over the last year, with food prices rising 0.4% month over month. This category has proven to be particularly stubborn, with the index for food at home rising 0.4% in September after being flat from July to August, and the index for food away from home increasing 0.3%.

Energy Prices Provide Some Relief

In contrast to the persistent pressures in shelter and food, the energy index provided some relief, decreasing by 1.9% in September after falling 0.8% in August. This was largely driven by a sizable 4.1% decline in gas prices last month. On a yearly basis, the energy index was down 6.8%.

Labor Market Resilience Complicates the Fed's Balancing Act

The Federal Reserve has been closely monitoring the labor market, which has remained surprisingly resilient in the face of high interest rates. The September jobs report showed the labor market adding 254,000 payrolls, more than the 150,000 expected by economists, while the unemployment rate fell to 4.1% from 4.2%.This strong labor market performance has altered expectations about the path forward for interest rates, with traders now pricing in a smaller 25 basis point cut in November rather than another jumbo 50 basis point cut. The Federal Reserve's minutes from its September meeting revealed that while a "substantial majority" of officials favored the larger cut, "some" wanted the smaller option, citing a resurgence in inflation as a primary concern.

Navigating the Delicate Balance: Inflation, Labor Market, and the Fed's Mandate

The latest inflation data and labor market resilience have created a complex challenge for the Federal Reserve. As Quincy Krosby, chief global strategist at LPL Financial, noted, "If inflation data continues to indicate that prices are generally rising amid a backdrop of a cooler labor market, the Fed's next meeting will undoubtedly involve a more heated discussion of which of the Fed's mandates takes precedence."The central bank's dual mandate of price stability and maximum employment has become increasingly difficult to balance, as the economy grapples with the lingering effects of high inflation and the resilience of the labor market. The potential emergence of a mild form of stagflation, characterized by elevated inflation and slower economic growth, adds further complexity to the Fed's decision-making process.As the central bank navigates this delicate landscape, the markets and the public will closely watch the Fed's next moves, eager to see how it will reconcile its competing priorities and steer the economy towards a sustainable path of growth and price stability.