US inflation higher than expected in September

US inflation was higher than forecast in September, raising the prospect that the Federal Reserve may raise interest rates following similarly robust recent data on the strength of the jobs market.

The consumer price index rose 3.7 per cent year on year, according to the Bureau of Labor Statistics, the same pace as the previous month. Economists had expected a slight decline.

On a monthly basis, inflation decelerated from 0.6 per cent to 0.4 per cent, thanks in part to lower pressure from energy prices. However, “core” inflation, which strips out volatile energy and food prices, remained steady at 0.3 per cent month on month.

Core inflation edged down from 4.3 per cent to 4.1 per cent on a year-on-year basis.

Alisher Khussainov, head of inflation at Citadel Securities, said the report was “a shot across the bow for the Fed”.

“The data we received — growth, payrolls, inflation — are all pointing in the same direction, and it points to an economy that is reaccelerating as opposed to an imminent recession . . . further heightened vigilance will be necessary from [the central bank’s] perspective.”

Many investors had been willing to look past a recent rebound in the headline inflation rate because it was driven by energy prices. However, Thursday’s report showed stronger than expected inflation in more core areas, particularly housing costs, which rose 0.6 per cent month on month.

“The shelter component is a bit worrisome,” said Agron Nicaj, US economist at MUFG. “It’s only one month of data so you don’t want to come to too many conclusions, but . . . it may be something the Fed needs to observe more closely going forward, they can’t assume it’s on a deflationary path.”

Stronger than expected jobs data last week had already fuelled concerns that inflation may become stuck above the Fed’s 2 per cent target.

Treasury yields rose after the CPI data was released, though they remained below the 16-year peaks hit after last week’s jobs data. But the bond market sell-off gathered pace during afternoon trading after an auction of new government debt was met with weak investor demand.

The two-year yield, which is particularly sensitive to interest rate expectations, was up 0.06 percentage point to 5.07 per cent, while the yield on the benchmark 10-year note jumped 0.11 percentage points to 4.71 per cent. Bond prices fall as yields rise.

US stocks sold off as Treasury yields climbed, with losses for both the S&P 500 and Nasdaq Composite topping 1 per cent in afternoon trading.

Traders also modestly increased bets that the Fed would raise interest rates another time before year-end, though the odds remain around 50/50.

Several Fed officials have suggested this week that higher Treasury yields could help to tighten financial conditions without the central bank needing to lift its own interest rate again.

That message had lifted stocks and Treasury prices in recent days, but Citadel Securities’ Khussainov cautioned that “if we continue to see easing financial conditions via rallying bonds and higher stocks, that will put the Fed in an uncomfortable position” given the strength of Thursday’s inflation report.

The federal funds rate has risen from close to zero in March 2022 to a range of 5.25-5.5 per cent. At the time of the Fed’s most recent policy meeting in September, officials were leaning towards the likelihood of another rate increase before the end of the year, followed by a slow pace of cuts over the next two years.

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