US inflation surge broadens
US Macro: Broad-based inflation acceleration – October CPI inflation came in much higher than our above-consensus forecast, with headline prices jumping 0.9% m/m, and core prices by 0.6%.
On an annual basis, headline inflation topped 6% for the first time since 1990, accelerating to 6.2% y/y from 5.4% in September, while core inflation rose to 4.6% from 4.0%. As expected, headline inflation accelerated on the back of pass-through from higher oil prices, as well as higher food inflation, but the main driver of the surprise was a jump in core inflation.
A rebound in used car prices was expected following the recent pickup in wholesale prices, but this was accompanied by a surprise jump in shelter, medical, and other services. To some extent this represents catch-up from the weakness we saw in services inflation last year – particularly in housing rents, which were essentially frozen for many months. However, it is likely that higher cost-push pressures are also being passed on to consumers, including from wage growth, with the employment cost index (ECI) up 3.7% y/y September – a near-17 year high – as well as other cost inputs, with PPI inflation accelerating to 12.5% y/y in October.
Inflation now likely to peak in early 2022, keeping Fed hike expectations elevated – With pipeline inflationary pressures proving to be stubbornly strong, and supply-side bottlenecks more persistent, we now expect US inflation to peak early next year (previously, we thought the peak was already behind us). Headline inflation is now expected to approach 7% y/y in the first few months of 2022, with core inflation topping 5% around this time. Thereafter, we expect a gradual easing in bottlenecks combined with a shift in consumption patterns away from goods and back to services to drive a turn-around in inflation dynamics. This should bring annual CPI inflation back to near the Fed’s 2% target by the end of 2022.
With inflation at multi-decade highs, the Fed is facing increasing pressure to respond more quickly to the current price surge, and following the release of the October CPI report, markets moved again to price more aggressive rate hikes next year. While our base case is that the first Fed hike will come in early 2023, market pricing for rate hikes is expected to remain elevated at least into early 2022, when we are likely to see a more convincing turn in inflation dynamics. (Bill Diviney)