How far is the "last mile" for the Federal Reserve? Focus on tonight's heavyweight CPI data.

Recent statements from Federal Reserve officials indicate that the signal of "possible further rate hikes" is being repeatedly emphasized. With one month to go until the December meeting of the Federal Reserve, the inflation data to be released tonight will be an important reference for whether to continue raising interest rates this year, following the latest statement by Fed Chairman Powell.

At 21:30 Beijing time tonight, the US Department of Labor will release the October CPI inflation data. The median forecast in the Bloomberg survey shows:

Overall inflation CPI in October will fall from 3.7% in September to 3.3%, with a MoM decrease from 0.4% to 0.1%;

The core inflation rate, which the Federal Reserve is more concerned about, will remain unchanged at 4.1% YoY and 0.3% MoM.

Analysts generally believe that under the influence of gradually falling energy prices, the slight increase in overall inflation in the past three months will return to a downward trend, but core inflation may rebound slightly due to rising housing costs.

For the Federal Reserve, it now needs to see continued cooling of employment and inflation to confirm a shift. However, the current decline in inflation is clearly not enough. Barclays believes that if core CPI accelerates slightly as they expect, with a MoM increase of 0.4% and a YoY increase of 4.2%, it is expected that the Federal Reserve will raise interest rates by 25 basis points in early next year.

However, the market does not believe that the Federal Reserve will raise interest rates again. According to CME FedWatch data, the probability of a 25 basis point rate hike in January next year is only 20%, while it is expected that interest rates will be cut three times by the end of next year, with a total decrease of more than 80 basis points.

Cooling Energy Prices Lead to a Decline in Overall Inflation

The recent cooling of energy prices has made the market more certain about the slowdown in overall inflation. Previously, the Israeli-Palestinian conflict was the biggest source of uncertainty for oil prices, but after the panic subsided, international oil prices weakened again, with WTI oil prices falling to $75 per barrel, back to the level of mid-July.

As a result, the price of gasoline in the United States (with a weight of 3.7% in the CPI basket) also fell to $3.25 per gallon, the lowest since January. Barclays predicts in its report that after seasonal adjustments, the decline in gasoline prices will be about 4.8%, twice the 2.2% decline in September, but natural gas and electricity costs will rise.

Morgan Stanley believes that the MoM increase in overall inflation is only 0.02% (compared to 0.40% in September), and the decline in gasoline prices is the main reason for the decline in energy inflation - it is expected that the energy consumption price index will decrease by 3.4% YoY. Food inflation has accelerated compared to last month, with a YoY growth rate of 0.38%.

Core Inflation Remains "Hot and Steady"

As a key inflation indicator that the Federal Reserve pays close attention to, the market expects the core CPI, which excludes energy and food, to maintain a growth rate of 4.1%. This may raise concerns about whether the Fed will reassess the need for further interest rate hikes in the future.

Analysts generally believe that the stubbornness of core inflation is mainly due to two factors: 1. The slowdown in the decline of used car prices and their gradual stabilization; 2. The strong expected MoM increase of 0.52% in core service inflation, mainly driven by the robust growth in accommodation prices and the fluctuation in medical insurance inflation.

Nomura believes that the prices of new cars and used cars, which have the highest weight in core CPI (about 7% in total), will stabilize in October after a sharp decline in September due to sample updates. At the same time, automakers have slowed down the extent of price reductions and promotions in October, thereby pushing up the prices of new cars in the CPI:

After October, we expect core CPI to gradually slow down as tighter car loan conditions and the end of automobile worker strikes indicate a resumption of price declines for cars.

Rental prices in October may continue to be a driving force behind the rise in core CPI. According to the Realtor.com rental report, there is strong demand for rentals, especially for low-priced apartments. The median rent for the 50 largest cities is $1,747, still significantly higher than pre-pandemic levels.

Barclays expects the housing inflation rate to fall to 0.50%, slightly lower than the September level of 0.56%. Despite more apartment supply coming onto the market, rents are still rising.

Analysts believe that in this report, the data most favored by the Federal Reserve, other core services excluding rent (also known as "super core inflation"), still have unstable factors. Nomura believes that super core inflation was 0.61% in September and may continue to remain at a high level of 0.59% in October:

Barclays states that one reason for the difficulty in reducing super core inflation is that hotel accommodation prices are expected to rise strongly again. Average daily rate (ADR) data for hotels shows that average room rates have increased in October compared to September. According to STR data, 60% of the growth in hotel industry revenue in the past 6 weeks came from weekdays, further proving the gradual recovery of business travel, which will also push up super core inflation. Additionally, hotel and leisure spending is expected to maintain growth.Supercore inflation is closely related to the labor market and is the main obstacle to further inflation decline. Last week, the University of Michigan's consumer survey found that both this year's and long-term inflation expectations have risen significantly. As US households shift their consumption from goods to services, the expansion of the service industry has become a key factor supporting the resilience of the US economy.

The Fed still faces inflation pressure

For the Federal Reserve, it needs to see continued softening in the labor market and cooling inflation to confirm a shift. Although the rising cost of borrowing in the US has begun to curb loan demand, thereby affecting economic activity and inflation, the current decline in inflation is clearly not enough.

Powell previously stated at an International Monetary Fund (IMF) seminar that the Fed may have more work to do in combating high inflation:

"The Federal Open Market Committee (FOMC) is committed to achieving a moderately restrictive monetary policy stance over time in order to bring inflation down to 2%; we are not confident that we have achieved this yet."

From the key sub-items mentioned earlier, including rent, used cars, and services, analysts believe that a significant part of the driving force behind future inflation cooling may come from a tightening financial environment that suppresses overall demand growth, which means that interest rates may remain high for a longer period of time.

The inflation data released tonight and in the coming months will help investors determine how long it will take for the Fed to complete the "last mile" in fighting inflation, thereby further confirming whether the Fed's path of interest rate hikes has been completed.

For the market, the combination of Fed monetary tightening and US fiscal expansion limits the downside of US bond yields.

Wall Street News previously analyzed that based on the market performance at the end of previous rate hikes, the "steep bull" shape of the yield curve is what the market hopes to see, corresponding to the end of the tightening cycle, when the US fundamentals weaken and trigger a shift in Fed policy towards easing, leading to a rapid decline in short-term interest rates. However, analysts believe that the likelihood of seeing this situation in the short term is not high.

When it comes to the potential impact on US stocks, analysts believe that the market's reaction to the CPI report released on July 12th may serve as a useful template:

At that time, the stock market reached its highest level of the year, and many saw the slower-than-expected year-on-year increase in CPI as an important turning point in the Fed's fight against inflation. Currently, inflation needs to accelerate significantly in order to have a negative impact on the stock market.