Another firmer-than-expected U.S. CPI (Consumer Price Index) inflation report for October 2021 strongly suggests that U.S. Federal Reserve officials will pull forward their expected timetable for raising the policy rate in an effort to manage the risk that long-term inflation expectations accelerate as a result of inflationary pressures and the resulting economic uncertainty. The Fed will release updated rate hike forecasts in December; following this latest CPI report, we believe the updated median Fed forecast could indicate two rate hikes in 2022 and three to four hikes in 2023.
The October CPI report showed prices across a wide range of retail goods rose more than expected as consumers pulled forward their holiday purchases, and the acceleration in shelter categories over the last two months was also firmer than expected. Continuing supply chain pressures and demand for automobiles also contributed to higher reported inflation.
CPI report breakdown
U.S. core CPI increased 0.6% month-over-month (m/m) in October, outpacing consensus estimates. Notably, the categories for rents and owners’ equivalent rents (OER) increased 0.4% m/m, a similar pace as September, but October’s acceleration was more broad-based across regions and population densities (rural and urban). Overall, a stronger economy, higher interest rates, higher home prices, and lower unemployment are all contributing to shelter price inflation’s recovery from recession-induced weakness. The October report suggests rental price inflation could accelerate above the pace that was prevailing prior to the recession faster than anticipated.
Elsewhere in the October CPI data, the retail goods category increased at a strong pace of 0.7% m/m, a report consistent with other high frequency economic indicators. It appears that media reports warning of empty shelves during the holiday shopping season have influenced consumer shopping patterns. This strong demand alongside already low retail inventories boosted prices for items like furniture (+0.8% m/m) and recreational goods (+0.4% m/m) in particular.
Meanwhile, auto price inflation reaccelerated. Used car prices rebounded 2.5% m/m in October after two months of price declines. Even though industry data suggests that used car inventory has recovered more than new car inventory, the combination of the need to replace cars damaged by Hurricane Ida when new car inventories were already very low once again boosted used car prices. We expect used car prices to continue to rise into year end, before declining next year. Meanwhile, new car inflation was also strong, up 1.4% m/m amid inventories near record lows. In positive news, third quarter earnings commentaries from several automakers suggest that the worst of the semiconductor supply issues may have passed, and gradual improvement in inventories over the next few quarters should ultimately help new car price inflation normalize in 2022.
Finally, despite the drop in U.S. COVID-19 cases over the past month, pandemic-sensitive service sectors were mixed in the CPI report. Hotel prices rebounded from two straight monthly declines as expected (+1.5% m/m), but airfares fell for a fourth straight month (−0.7% m/m). Even though airlines generally beat earnings expectations in the third quarter and expect robust holiday travel, weakness in prices may suggest that a different mix of travelers is driving the decline. The second half of the year is generally the prime season for business travelers, who tend to pay higher rates, and the delays in returning to office due to the Delta variant could be behind some of the weakness.
Implications for Fed policy
Overall, the October U.S. CPI report reaffirms that the Fed is in an uncomfortable place. (For details, see our blog coverage of the November Fed meeting.) While we expected that the next several months would be challenging for the Fed to navigate, the stronger-than-expected price gains in October, especially in the stickier shelter categories, all but confirm that Fed officials will once again revise their inflation and rate path forecasts in the December 2021 summary of economic projections (SEP). We expect the revised median Fed forecast will imply two rate hikes in 2022 (and another three to four hikes in 2023), which suggests the Fed is likely to begin hiking soon after the bond purchases end.
For now, we expect the pace of tapering of asset purchases to continue at $10 billion per month for U.S. Treasuries and $5 billion per month for agency mortgage-backed securities (MBS). However, we wouldn’t be surprised to see more calls for Fed officials to speed up the taper in January, when they will need to announce the ongoing pace.
Tiffany Wilding is an economist focused on North America and a regular contributor to the PIMCO Blog.
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