The deflator for September was as positive for the stock market as it could have been, given the CPI report for that month. The discrepancy with the CPI marginally improves the optics for the Fed, but it does not solve the underlying inflation problem.
Wages are still rising at a rate that is consistent with underlying inflation well above the Fed’s 2% inflation target. This is because the US remains far below its NAIRU.
Overall, the y/y for the wages & salaries ECI eased from 5.27% to 5.06%, but the q/q gain was again strong (5.38% annualised). Initial claims edged up only 3k to 217k in the week ending October 22nd: the labour market remains very tight.
The latest nowcast models have the core deflator rising 0.42% m/m in October: the y/y is projected to firm again from 5.15% to 5.16%. It is rare to get sustained m/m declines in the core deflator outside of major recessions. Even during the financial crisis, the core deflator (ex-food & energy) fell only 0.27% between Sep 08 and Jan 09.
Ultimately, underlying wage inflation of 5% makes it very difficult to get inflation down towards target quickly without a large adverse shock to the economy.
There will inevitably be a gradual slowdown in the pace of rate hikes. But standing pat on a federal funds rate of 4.50-4.75% (4.6% median for 2023, from the latest SEP) is a very different proposition to anything seen in well over a decade, and is likely to expose areas of leverage in the economy.
The US stock market remains susceptible to upside inflation surprises. The path for a soft landing remains very narrow.
