Recent headlines might have you worried about the state of inflation in the United States. Following the release of September’s inflation data by the US government, concerns about rising prices are in the spotlight. The consumer price index (CPI) indicated a 3.7% increase from a year earlier, mirroring August’s numbers. However, what many headlines missed is the crucial story behind the numbers – the core, or underlying, inflation.

Core inflation is a metric that excludes the influence of volatile factors like food and energy prices, offering a more stable view of price changes. In September, core prices were up 4.1% from a year earlier, a slight decrease from the 4.3% recorded in August. This suggests that core inflation is making gradual progress, despite the headline numbers.

Understanding how the latest inflation report is interpreted is pivotal, especially for the leaders of the Federal Reserve, as they have to make crucial decisions regarding interest rates later this month, largely based on their interpretation of the most recent inflation data.

Let’s break down the data:

• In September, consumer prices rose by 3.7% from the previous year and by 0.4% from the previous month.
• Energy prices decreased by 0.5% from the previous year but increased by 1.5% from the previous month, partially due to rising crude oil prices. However, crude prices have since declined, which may lead to a drop in the energy component of the CPI and subsequently a decrease in annual inflation.

Crucially, the majority of inflation is concentrated in services. Durable goods prices fell by 2.2% from a year earlier, while nondurables saw a modest increase of 3.2%. Service prices, on the other hand, rose by 5.2%, largely due to the continued sharp rise in shelter (housing) costs, which increased by 7.2% from a year earlier. If shelter is excluded from the calculation, service prices only increased by a modest 2.8%, and overall inflation, when excluding shelter, was only 2%.

The recent statements from various Fed leaders suggest a bias toward leaving interest rates unchanged at the next meeting. If they perceive inflation as stubbornly high, they might lean towards raising rates. However, the most recent data, especially the core measure of inflation, suggests otherwise. Some Fed leaders have also pointed out that the surge in bond yields is helping to address the inflation concern, reducing the likelihood of a rate hike.

The Fed’s primary concern regarding inflation remains the state of the labor market, which is currently tight. Job growth was robust in September, and the job openings rate increased. Despite this, labor cost inflation is gradually receding, which aligns with the Fed’s objectives. The question remains: Will the Fed raise interest rates due to tight labor market conditions, or will they leave rates unchanged if wage acceleration is not observed? Only time will provide the answer.

Recent events have also seen a significant decline in bond yields, particularly in the United States. Several factors contribute to this trend:

1. Comments from the President of the Federal Reserve Bank of Dallas, suggesting that the rise in bond yields reduces the need for short-term rate increases.
2. Data indicating that underlying inflation is improving, reducing the necessity for further monetary tightening.
3. The possibility that the US economy is slowing, with recent purchasing managers’ indices pointing towards a potential slowdown in the fourth quarter.

These factors have led some investors to believe that the last interest rate hike in July could be the last for this economic cycle, and many do not expect further rate increases. This shift in expectations has contributed to the decline in bond yields and a subsequent rebound in equity prices.

The International Monetary Fund (IMF) has also issued warnings regarding the impact of rising bond yields. The sharp increase, even if partially reversed, could pose a threat to financial market stability. The IMF highlighted potential issues for medium-sized commercial banks, such as the need to downgrade asset values and an increase in defaults on commercial property mortgages, which could lead to a negative feedback loop affecting credit markets.

While the IMF is cautious, US Treasury Secretary Yellen has stated that higher yields have not disrupted financial markets. Yellen emphasized that strong demand for labor hasn’t caused overheating in the labor market and that core inflation remains well-behaved.

Shifting our focus to Germany, the country faces numerous challenges. The German economy is not growing, and the government anticipates a 0.4% decline in real GDP in 2023. The energy shock resulting from the war in Ukraine, which led to a sharp rise in natural gas prices and subsequent inflation, has taken a toll on the German economy. Additionally, a global economic slowdown, especially in China, has negatively impacted German exports. Furthermore, recent disruptions, including the Hamas attack on Israel and damage to a gas pipeline, threaten to revive inflation and affect ECB monetary policy. A labor shortage, in part due to pandemic-related labor supply constraints, has also put upward pressure on wages and limited output.

While the labor market remains tight in advanced economies, the OECD’s latest data suggests that labor force participation has grown significantly, potentially alleviating wage pressure. The rise in employment, low unemployment rates, and a reduction in the inactivity rate for working-age people could mitigate inflationary pressures. The OECD’s positive report on employment may influence the decisions of major central banks concerned about tight labor markets.

In conclusion, the headlines may suggest concerning trends in inflation and the economy, but a deeper analysis reveals a nuanced picture. The path forward will depend on how various economic indicators and factors evolve, including the Federal Reserve’s decisions and global developments.