Can the Federal Reserve pause rate hikes in November? Focus on tonight's heavyweight CPI data.

Three weeks before the November Federal Reserve meeting, the hot job market and higher-than-expected PPI are not good news for the Fed. The heavyweight CPI data to be released tonight will be an important reference for the Fed's decision on whether to continue raising interest rates this year.

At 20:30 Beijing time tonight, the US Department of Labor will release the September CPI inflation data. The median of Bloomberg's survey shows:

The year-on-year growth rate of CPI in September may slightly decrease from 3.7% last month to 3.6%, and the month-on-month growth rate may slow down from 0.6% last month to 0.3%.

Due to the continued slowdown in rental price pressure, the core inflation rate, excluding food and energy costs, is expected to decrease from 4.3% last month to 4.1%, and the month-on-month growth rate is expected to remain at 0.3%, the same as last month.

Analysts pointed out that the surge in energy and service prices caused the September Producer Price Index (PPI) to rebound beyond market expectations, which also brings greater uncertainty to the CPI data.

In recent days, several Federal Reserve officials have stated that with the sharp rise in US Treasury yields, which tightens financial conditions, the Fed may stop raising interest rates. More and more traders are betting that the Fed may not raise interest rates further in November, December, or even January next year.

According to the CME FedWatch data, the probability of the Fed pausing interest rate hikes in November has reached 91.5%, almost a certainty.

However, some analysts believe that the remarks of the Fed officials did not take into account the September inflation data. Historical data shows that the longer inflation persists, the more difficult it is to bring it down. Geopolitical factors are currently disrupting energy prices, and if there is a repeat of the oil price shocks of the 1970s, inflation may remain high for a longer period of time, becoming a major variable affecting the Fed's policy path.

UBS believes that in terms of overall CPI, energy prices are expected to rise by 1.0% in September, with a slower growth rate compared to the previous month but still strong. Food prices are expected to rise by 0.28%, driving a 0.3% month-on-month increase in overall CPI. UBS stated that although energy and food inflation are still higher than pre-pandemic levels, they have significantly slowed down from their peak.

Goldman Sachs predicts the following based on core CPI: 1. Used car prices will decrease by 2.3% in September, and new car prices will decrease by 0.1%. 2. Car insurance prices will rise by 1.7% in September. 3. Housing inflation will roughly remain the same as in August (with normal rent increasing by 0.48% and equivalent rent for homeowners increasing by 0.45%).

Can energy prices drive CPI?

Analysts generally believe that energy prices will continue to drive overall CPI growth in September, but the magnitude will be more moderate than in August.

In a report, Michael Ferol, Chief Economist at JPMorgan Chase, pointed out that energy prices are expected to rise by 1% in September, a significant slowdown from the 5.9% inflation reported in August. UBS analysts predict a 1.0% increase in energy prices in September, with a weaker growth rate.

However, based on the PPI data for September released yesterday, although the base effect has further weakened, energy prices may still be an important driver of inflation. Final demand energy prices rose by 3.3%, with gasoline prices rising by 5.4%.

Some believe that with the escalation of the situation in the Middle East, energy prices may once again become a factor affecting prices. For the Federal Reserve, it is far from the time to declare victory.

For food prices, JPMorgan Chase analysts expect food prices to continue to rise in September, with a MoM increase of 0.2%, close to the average level. UBS believes that food inflation has continued to slow down over the past year, and it is expected to rise slightly by 0.28% in September:

Among them, the price of eating out at restaurants has dropped significantly from last summer's peak, but the growth rate is still high.

Core inflation is expected to continue to decline

If core inflation in September cools down further as expected by the market, it is expected to alleviate the current pressure on the Federal Reserve to some extent. The market generally expects that core CPI in September will drop from 4.3% to 4.1%.

Goldman Sachs stated in a report that it expects used car prices to decline by 2.3% and new car prices to decline by 0.1%, reflecting the overall decline in used car auction prices during the summer, increased dealer promotional incentives, and increased new car inventory.

However, UBS believes that the stabilization and rebound of used car prices has led them to raise their expectations for core inflation. Manheim's wholesale used car prices rose by 1.0% compared to August, and transaction prices indicate a moderate increase in new car prices in September:

This is mainly because the market is concerned that the strike by the United Auto Workers (UAW) may slow down new car retail sales and shift buyers to the used car market. As there is no sign of the association strike ending yet, it may continue to be an unstable factor in price fluctuations in the short term.

JPMorgan Chase stated that industry data indicates recent strength in car prices, with used car prices expected to rise by 1.3% in September and new car prices by 0.3%.Goldman Sachs believes that car insurance prices will remain strong in September, with an expected increase of 1.7%. In the past three months, average car insurance prices have risen by 2.0%:

It is expected that in September, with the continuous increase in car repair and replacement costs, car insurance prices will continue to rise.

In terms of housing, Goldman Sachs believes that the pressure on rental prices will ease, and it predicts that housing inflation in the CPI will remain basically the same as in August:

It is expected that normal rent and owner's equivalent rent (OER) will remain weak, with MoM increases of 0.48% and 0.41% respectively. As the gap between new lease and ongoing lease rents continues to narrow, housing inflation will remain at its current level.

UBS points out that according to the ApartmentList National Rent Report, the national rent index decreased by 0.5% MoM in September, further accelerating from August, marking two consecutive months of decline and basically returning to pre-pandemic levels:

UBS predicts that core service prices, excluding rent, will rise by 0.43% in September, mainly due to the steady increase in prices of travel-related services:

Weekly hotel data shows that the price of accommodation in September increased by about 1%.

Will the Federal Reserve raise interest rates this year?

Regarding future inflation trends, Goldman Sachs predicts that due to the continued slowdown in housing inflation and the decline in used car prices, the MoM growth rate of core CPI will remain within the range of 0.2%-0.3% in the coming months. The bank expects the YoY inflation rate of core CPI to be 3.8% in December 2023 and 2.9% in December 2024.

UBS, on the other hand, predicts that the core CPI inflation rate will continue to slow down this year, with MoM growth rates of 0.23%-0.24% in November and December. Downward pressure on price increases is due to the slowdown in rent increases, the decline in used car prices, relaxed supply conditions, and slower wage growth. The trend is expected to gradually decline for most of next year:

Federal Reserve Chairman Powell emphasized at the September monetary policy meeting that officials will make decisions on monetary policy based on data, and tonight's CPI data will also be an important basis for judging the Fed's effectiveness in combating inflation.The recently released minutes of the meeting showed that at the Federal Reserve's monetary policy meeting in September, policymakers unanimously agreed to keep interest rates high for "some time" and advocated "caution" in making interest rate decisions. However, compared to the minutes of the July meeting, the content of the September minutes was somewhat dovish.

Some analysts believe that there were not many surprises in these minutes, and the models show that the Federal Reserve's attitude is neutral. Unless the CPI inflation data to be released this Thursday is surprisingly high, the next Federal Reserve meeting in November is likely to decide to continue the pause in interest rate hikes.

Lara Rame, Chief US Economist at FS Investments, said that the Federal Reserve can certainly claim progress in fighting inflation, but they cannot declare victory. Regarding the Federal Reserve's policy choices going forward, Rame believes that the "last mile" may be more difficult and it may take until early 2025 to reach the 2% target. Therefore, the Federal Reserve will maintain its current policy stance and keep interest rates at a restrictive level.

How will the market react?

JPMorgan Chase's predictions for the market reaction after the release of the CPI tonight are as follows:

• 5% probability: Overall CPI MoM increase of more than 0.6%

The S&P 500 will fall by 1.5%-2%. This will raise concerns in the market about an oil price shock similar to that of the 1970s, and inflation data will start to rise sharply again. Commodity prices and core prices will lead the overall data higher, triggering a sell-off of risk assets and increasing the possibility of rate hikes in November and December.

• 27.5% probability: Overall CPI MoM increase between 0.4% and 0.6%

The S&P 500 will fall by 0.75% - 1.25%. Although not as extreme as the previous scenario, the bond market may reflect a more hawkish stance by the Federal Reserve, or raise the peak interest rate to 6%, which could lead to a narrative of the economy entering stagflation.

• 45% probability: Overall CPI MoM increase of 0.3% (in line with expectations)

The S&P 500 will rise by 0.4% - 0.75%. Although it has not yet reached the target expected by the Federal Reserve, it is quite close, so the market will raise expectations of a pause in interest rate hikes by the Federal Reserve.

• 20% probability: Overall CPI MoM increase between 0.2% and 0.3%

The S&P 500 will rise by 1% - 1.5%. This will further solidify the argument of continued cooling of inflation and shape the scenario of the "golden-haired girl".

• 2.5% probability: Overall CPI MoM growth rate below 0.2%

The S&P 500 will rise by 1.5%-2%. The market will see the Federal Reserve starting an interest rate cut cycle earlier, and the Federal Reserve will be closer to announcing "mission accomplished".From the perspective of core inflation data, Goldman Sachs predicts that if the MoM increase in core inflation in September is between 0.1% and 0.15%, the S&P 500 will rise by 1.5%; if the MoM increase in core inflation in September is between 0.15% and 0.2%, the S&P 500 will rise by 1%; if the MoM increase in core inflation in September is between 0.2% and 0.25%, the S&P 500 will rise by 0.75%; if the MoM increase in core inflation in September is between 0.25% and 0.3%, the S&P 500 will rise by 0.25%; if the MoM increase in core inflation in September is higher than 0.35%, the S&P 500 will decline by 1.5%.

Analysts believe that after strong PPI data, if tonight's CPI data continues to exceed expectations, it may alleviate the recent decline in the US dollar index.