Energy drives up overall inflation, but core pressures marginally ease, providing grounds for the Federal Reserve to stand pat in October.

Written by: Zhang Yaqi, Wall Street Watcher

Energy prices once again dominate the inflation trend, but core pressures are easing, supporting the Federal Reserve's decision to keep rates unchanged in October.

The U.S. Bureau of Labor Statistics will release September CPI data on October 14 (next Wednesday). According to news from the trading desk, Barclays and Morgan Stanley predict that the overall CPI for September will accelerate due to a sharp rise in gasoline prices, but the month-on-month increase in core CPI is expected to narrow slightly compared to August, mainly because the price increase for wireless communication services has partially subsided. Both institutions forecast the month-on-month increase in core CPI to be 0.24%, down from 0.29% in August.

This data will directly impact the Federal Reserve's decision at the October monetary policy meeting. Barclays Research believes that despite the recent inflation risks still leaning upwards, Fed officials are likely to maintain interest rates unchanged in October to continue observing subsequent data, pushing the 25 basis point rate hike path to December.

Earlier, the minutes from the September meeting released by the Federal Reserve showed that "most" officials expect one more rate hike this year but indicate that there is no rush for October. Federal Reserve Governor Waller stated that rate hikes do not need to occur in consecutive policy meetings, and officials can flexibly time their actions based on economic data. The market has postponed rate hike expectations from October to December, and Goldman Sachs believes the probability of a December rate hike is greater, but the FOMC's final judgment that no further tightening is needed is also quite likely.

Energy drives overall inflation, headline data jumps

Barclays predicts that the overall CPI will rise by 0.58% month-on-month (seasonally adjusted) in September, with a year-on-year increase to 3.7%, up about 0.3 percentage points from August's 3.4%, although still below the peak of 4.2% in May this year. Morgan Stanley's prediction is slightly higher, with a year-on-year increase of 3.69% and a month-on-month increase of 0.62%.

Energy is the core driving force behind the jump in overall inflation. According to Barclays, the month-on-month increase in the energy component is as high as 5.05%, with gasoline prices soaring by 9.23% month-on-month and a year-on-year increase of 34.8%; heating oil has a year-on-year increase as high as 38.8%.

Morgan Stanley points out that the ongoing tension in the Middle East is a significant factor driving up oil prices, which will further transmit into airline ticket prices and transportation costs. The Barclays research team also warned in a previous report that the rise in diesel prices is gradually being passed on to U.S. consumers.

Core inflation slightly eases, wireless communication fall is the main reason

While overall inflation rises, the pressure on core CPI has slightly eased. Barclays predicts that core CPI will rise by 0.24% month-on-month and 2.5% year-on-year in September; Morgan Stanley’s prediction is in agreement, also at 0.24%, both down 5 basis points from August's 0.29%.

The main driver for the easing of core inflation comes from the "Education and Communication" component. In August, the price of wireless communication services unusually surged, contributing about 0.1 percentage points to core CPI in a single month. Barclays predicts that Verizon's latest round of price increases combined with AT&T's planned smaller price hikes will still contribute to inflation in September, but the magnitude will be significantly smaller than last month.

Meanwhile, airline ticket prices and medical service prices continue to be supporting factors for core inflation. Morgan Stanley notes that airline ticket prices already rose by 23% year-on-year in August, and they still project a month-on-month increase of 1.8% for September; Barclays forecasts a 2.6% month-on-month rise in airline ticket prices. Morgan Stanley adds that jet fuel prices have nearly a 90% year-on-year increase, and since fuel accounts for about 20% to 30% of an airline's operating costs, based on this calculation, airlines may already be nearing complete price pass-through for the rise in fuel costs. Additionally, after weakening in August, medical services are expected by Morgan Stanley to rebound by 0.55% month-on-month in September.

In terms of core goods, Barclays and Morgan Stanley predict month-on-month increases to remain in the range of 0.13% to 0.14%, roughly flat with August, with slight strengthening in prices for new and used cars.

Housing inflation stabilizes, insurance drag persists

The housing component continues a stable trend. Barclays predicts that the Owner's Equivalent Rent (OER) will rise by 0.24% month-on-month in September, with primary residence rents increasing by 0.23%; Morgan Stanley forecasts OER and primary residence rents at 0.25% and 0.20% respectively. Morgan Stanley notes that since May of this year, the average monthly increase in housing inflation is about 0.24%, slightly below the pre-pandemic long-term trend of 0.26%, and is expected to fluctuate around this level in the near term.

Auto insurance continues to drag on core inflation. Morgan Stanley predicts that auto insurance premiums will decline by 0.20% month-on-month in September and expects that negative growth will continue until 2027, mainly due to improvements in insurance companies' profitability, prompting them to lower prices to compete for market share.

Regarding hotel prices, there was a strong rebound in August after two months of unusual weakness, and Morgan Stanley predicts that September will return to flat (0% month-on-month).

PCE inflation forecast: expected to remain around 3%

The CPI data also has guiding significance for the PCE inflation indicator, which is of greater concern to the Federal Reserve. Barclays forecasts the core PCE inflation for September to be 0.22% month-on-month, approximately 3.0% year-on-year; Morgan Stanley’s prediction is slightly higher, at 0.23% month-on-month.

Barclays researchers Pooja Sriram, Marc Giannoni, Jonathan Millar, and Colin Johanson point out that there is some uncertainty in the financial services PCE price, especially since the Bureau of Economic Analysis (BEA) is using a new method to estimate the prices for portfolio management services, and the nominal expenditure and labor hour data required may not be readily available, complicating forecasting. The team stated they would further revise their forecast after the release of the CPI and PPI data next week.

Federal Reserve path: unchanged in October, 25 basis points hike in December

From a policy path perspective, Barclays maintains its baseline prediction: the Federal Reserve will raise rates by 25 basis points in December. The institution points out that due to the base effect drag, the medium- and long-term inflation metrics preferred by Chairman Waller, such as the 6-month and 12-month measures, are unlikely to show significant improvement this year, but the outlook for 2027 will be significantly better.

Recent statements from Federal Reserve officials indicate that the uncertainty in the distribution of inflation outcomes may support further tightening from a risk management perspective, but Barclays anticipates that decision-makers will choose to stand pat in October, waiting for more data verification.

It's worth noting that Morgan Stanley reminds that there are several key variables in this report that need close monitoring: first, when Apple announced new iPhones on September 9, it raised prices on some old models by 10% to 14%, but since smartphones only account for about 0.2% of the CPI basket, and some regions are sampled bi-monthly, the direct impact is expected to be no more than 1 to 1.4 basis points; second, whether the further increase in airline ticket prices is nearing a ceiling; third, whether housing inflation can maintain its current stable pace.