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Below the Quote on US inflation: An unpleasant disappointment masks a lower underlying trend By David Kohl, Chief Economist, Julius Baer

September’s US inflation report disappointed at first glance, as higher energy and shelter costs pushed both headline and core inflation above expectations. Yet inflation pressures remain narrowly concentrated, while broader price trends continue to moderate. We therefore maintain our view that the Fed is nearing the end of its tightening cycle.

US headline inflation accelerated in September to 3.7% on the back of a 9.1% monthly increase of energy prices. The 0.6% monthly increase in the consumer price index was driven mainly by higher energy prices, which contributed 0.39 percentage points. Higher overall inflation had been largely expected and only marginally exceeded market expectations. The unpleasant surprise came from core consumer price inflation that excludes volatile food and energy prices. Core inflation increased by 0.33% from a month earlier, compared with expectations for a milder increase of just 0.2%. Core goods prices increased slightly with used cars and recreation commodities prices rising, and the memory chip shortage continued to exert upward pressure on prices. The largest contribution to core inflation came from shelter, which accounts for more than 35% of the inflation basket. The estimated owners’ equivalent rent component accelerated despite a cool housing market, suggesting a possible anomaly. As inflation has been driven up once more by just a few categories and breadth of inflation declined, we see the financial market reaction as exaggerated. Money markets are pricing in a higher probability of a rate hike at the next FOMC meeting at the end of October, but implied probabilities remain below 50%, and expectations of a rate hike in December have been confirmed. Expectations of additional rate hikes in 2027 have firmed. We continue to see less inflation pressure in 2027 due to favourable base effects and the fact that outsized price gains in core inflation categories mask the moderate underlying inflation trend. As such, we stick to our view that the pressure on the Fed to hike rates will decline in 2027 and policy rates will remain unchanged for most of 2027.

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