An inflation measure watched closely by the Federal Reserve has fallen to its lowest level in more than two years, signaling that the central bank's push to fight rising prices with higher interest rates is nearing an end.
The core consumer price index, which strips out volatile food and energy prices, increased 4% from October 2022 to October 2023, the smallest yearly increase since September 2021, the US Bureau of Labor Statistics reported Nov. 14.
Since peaking in September 2022, annual core CPI growth has fallen by an average of 20 basis points each subsequent month, putting it on track to reach the Fed's goal of 2% by the end of summer 2024.
Overall CPI increased 3.2% year over year, the lowest rate of annual growth since June, essentially eliminating the chances of another Fed rate hike before the end of the year.
The odds of a hike at the Fed's December meeting stood at about 5% on Nov. 14, down from about 29% a month earlier, according to the CME FedWatch Tool, which measures investor sentiment in the fed funds futures market. A majority of the futures market now sees the Fed beginning to cut rates in May 2024, about a month earlier than expected before this latest inflation report.
"We are very data-dependent at this point," said Todd Walsh, CEO and chief technical analyst of Alpha Cubed Investments. "If we continue to see marginal improvement around the inflation prints, it will be many months before the Fed seriously considers cutting rates. If, on the other hand, the economy cools quicker than currently expected, the Fed's hand will be forced and they will accelerate the move to rate cuts."
While the Fed did not raise rates at three of its past four meetings, Fed Chairman Jerome Powell has repeatedly warned that the central bank will not ease monetary policy until inflation growth nears 2%. The Fed does not necessarily need to see inflation at 2%, but it needs to be confident that it is on the path toward that number, said Matthew Bush, US Economist for Guggenheim Investments.
"It's going to take a couple more reports like this," said Bush, who expects core inflation to near 2% in the second quarter of 2024 as the economy slows and the labor market weakens.
Without that forecast weakness in the jobs market, however, wage growth may continue to rise, keeping inflation elevated, said Andrew Schneider, a senior US economist with BNP Paribas.
"The bottom line for the Fed is that they still want to be wary," said Schneider, who expects the Fed could cut its benchmark interest rate by 125 basis points in the second half of 2024 if inflation growth stays on track toward 2%. "We could still need a weaker labor market to get us all the way back to target."
While inflation growth has slowed overall, some prices did increase substantially in October.
Services, not including energy services, for example, increased 6.7% over the past year. Residential rents rose 6.8%.
Rental inflation is contributing about 2% to the annual growth of core CPI and is likely to decline soon since government housing data can have a lag of nine months to a year, said Bush with Guggenheim.
Also within services, transportation services increased 9.2% over the past year, motor vehicle repair climbed 15.1% and admission to sporting events jumped 25.1%, as recreation services prices continued to soar.
"The services sector is almost a proxy for the entire economy, which has been surprisingly resilient in the face of higher interest rates and multiple rate increases by the Fed," said Walsh with Alpha Cubed Investments.