September CPI Inflation Report Worst Case Scenario for Fed, Biden, Stocks

  • Inflation rose more than expected in September, raising new questions about the future of the economy.
  • The Fed’s anti-inflation efforts have not worked, fueling speculation about rising interest rates.
  • The White House may suffer ahead of the midterms, while Fed tightening may continue to weigh on stocks.

Some economic data releases are hugely complicated, leaving experts and ordinary Americans more confused about the nation’s economic health.

But the September inflation report was crystal clear in pointing to trouble ahead. Almost every detail inside painted a bleak picture of the country’s near future and made a self-inflicted recession even more likely.

The consumer price index rose 0.4% in September and showed a year-on-year pace of 8.2%, both measures beating economists’ forecasts. Core inflation, which excludes volatile food and energy prices, rose 0.6% last month for a year-on-year increase of 6.6%. It marked the fastest growth in core prices since 1982.

The details of the report were equally grim. Shelter inflation replaced food and gas prices as the biggest driver of headline inflation, accelerating to the fastest one-year pace since 1982. Inflation for medical care and transportation services such as airlines and mass transit also worsened during the month.

For the Federal Reserve, the new data makes its fight against inflation – which has included several historically large rate hikes – look futile. For the stock market, the prospect of further Fed tightening is a major headwind with indices already near 2022 lows. And the White House now has to contend with a new batch of negative inflation headlines just weeks before the hugely consequential midterm elections.

Investors stare down a market bill

The stock market’s path through 2022 has been simple: If it looks like the Fed will slow its hike cycle, investors cheer and stocks rise. Conversely, signs that the central bank will continue to tighten typically lead to sudden falls and fears of an economic slowdown.

The first hours of Thursday’s trading session met that precedent. The S&P 500 plunged as much as 2.4% shortly after markets opened as investors read the report as a clear sign that the Fed will continue its hiking plans, although those losses reversed by midday and stocks bounced back into the afternoon.

Options traders are now pricing in 0.75-point interest rate hikes for both the Fed’s November and December meetings. Such measures would put a heavy brake on economic growth.

That leaves equity investors with a steep upward climb through the rest of this year and into 2023. Higher interest rates make borrowing more expensive for companies, which typically slows corporate earnings growth, and traders will set an even higher bar for companies to clear when they start going public with their quarterly earnings.

“These inflation numbers will be a major pain point for markets. The upcoming earnings season will need to be doubly strong to offset the strong headwinds of what will be an ever-aggressive Fed,” Yung-Yu Ma, a chief investment strategist at BMO Asset Management, said. “The earnings season may not be bad, but being strong enough to turn this tide will be a tough game.”

With several major rate hikes surely on the way, trading is likely to become more volatile before cooling off.

Strong inflation leaves the door wide openr Bold to keep up his fast walking pace

The September CPI reading could have made investing much more complicated, but it makes the Fed’s decision-making process much easier.

Projections from central bank officials in September already signaled the Fed would raise interest rates by another three-quarters of a percentage point in November, before dropping to a half-point increase at its December meeting. Market positioning heading into Thursday morning reflected this projection.

The new inflation figures changed the outlook in minutes. Markets are now bracing for back-to-back increases of 0.75 points through the end of the year as well as continued increases through early 2023.

“After today’s inflation report, there can be no one left in the market who believes the Fed can raise rates by anything less than 75bps at the November meeting,” said Seema Shah, global chief strategist at Principal Asset Management. “Slow growth and yet rising inflation — the combination none of us, least of all the Fed, wants to see.”

With Fed officials consistently hinting that their tightening plans are far from complete, significantly higher interest rates are virtually a given for at least the next year.

Worse-than-expected inflation jeopardizes Democrats’ already shaky election hopes

Thursday’s report was Democrats’ last chance to win a surprise cooling in inflation that they could campaign on through Election Day.

What they got was a worst-case scenario. Republicans already favoring wresting control of the House now have a new talking point relevant to all Americans, and as campaigns enter their final spurts, rising inflation could even dent Democrats’ hopes of retaining the Senate.

That likely dooms the Biden administration to a dull two years before the 2024 election. Democrats’ tenuous control of Congress allowed President Joe Biden to pass much of his legislative agenda, albeit with many packages slimmed down. Still, much of the backlash — from both Republicans and moderate Democrats — centered around the policies that pumped more money into the economy as inflation was rising.

With core inflation higher than at any point during the pandemic, Republicans are poised to push spending cuts and deficit reduction should they take the House. Chances for bipartisan policymaking will be few and far between, and until inflation shows clear signs of abating, the GOP will likely aim to reverse many of the White House’s recent victories.

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