October 18, 2016–As expected, the Consumer Price Index (CPI) jumped in September in y/y terms. It reached 1.5%, the highest in nearly two years since the 1.7% posted in October 2014 as gasoline prices were plummeting that year. Today’s report just barely eclipses the January 2016 figure of 1.4%, but we expect it to keep moving higher. Core CPI remained steady at 2.2%.

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Source: Bureau of Labor Statistics

The reason for the upward move in headline CPI was gasoline prices as we have discussed in earlier posts. Although gasoline prices have not moved up significantly, the base effects of y/y calculations are coming into play. In the August CPI report, gas prices were down 18% y/y and dragged the overall CPI down by about -0.6%. Today’s report showed -6.5% for gasoline for the month of September, which brought the drag to about -0.2% in this morning’s report. We are midway through October and know that the rollover in the y/y calculation continues as shown in the graph below. As of October 17 the y/y change was nearly gone. By the end of this week we are likely to see y/y daily gas prices in positive terms for the first time since July 2014. Accordingly, one month from now we would expect to see gasoline prices with zero drag on CPI or perhaps a small positive.

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Source: U.S. Energy Information Administration (EIA)

 But gasoline prices are only part of the story. Elsewhere the biggest drags on inflation continued to be food and autos. New vehicles appear to have flattened out in y/y terms after aggressive pricing from dealerships for most of this year. Used cars were down 4.1% y/y in this report. The items keeping Core CPI above the 2% level were continued upward movements in shelter, transportation services, and medical care services. All told, service inflation was 3.2% y/y, and does not show any sign of slowing.

Core Narrative

Today’s report is supportive of our core narrative of inflation returning back above 2% as energy prices roll over in y/y terms. If gasoline prices simply remain where they are today, they would add to headline CPI in November, December, January 2017, and especially in February 2017 because of the base effects. More important than the volatile energy prices is that core inflation remains steady above 2%. This is supportive of our view that the Fed is likely to hike interest rates more quickly than the market is pricing in, but still at a gradual pace. We currently expect a hike in December and then 2 more in 2017.

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Source: Bureau of Labor Statistics

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