Published 11 Oct, 2023
Following the fastest rise in interest rates in decades, the hiking cycle in the US might just be coming to an end despite inflation staying higher for longer. However, economic indicators have continued to paint a mixed picture over the last few weeks, making the terminal interest rate difficult to predict.
Currently, the Federal Reserve is proceeding with caution and adopting a wait-and-see approach. With certain areas of the economy beginning to falter and increasing concerns over the government deficit, it is likely the Central Bank will hold interest rates at its next meeting in November, but chances are high that rates will see an increase again before the end of the year.
Truflation’s real-time US CPI index also paints a mixed picture. Having risen from a low of 2.1% on August 12 to 2.66% on September 27, the index has since retreated to 2.46% as of 10 October. Despite this, we maintain our year-end projection for BLS inflation of 3.5%-4% – well above the Fed’s 2% target.
On a longer-term basis, Truflation’s recently launched aggregate US inflation data shows that the purchasing power of the average American has been eroded by a staggering 20.35% over three years to October 10, 2023, as a result of inflation. Let’s dig into the factors that affected inflation in September.
The US economy: Easy disinflation is over
One thing is certain: the era of easy disinflation is over. We expect the year-to-date deceleration in headline CPI to continue this month, with inflation dropping from 3.7% to 3.6%. However, on a monthly basis we see inflation rising by 0.15%.
While goods prices have fallen on the back of lower vehicle prices, costs in the services category remain stubborn. This, combined with the tight labor market and the impact of interest rates on household expenditure, supports our year-end projection for a headline inflation rate of 3.5%-4%. We don’t expect inflation to begin cooling until 2024.
Currently, inflation is primarily driven by higher oil prices, which feed through to utilities and gasoline prices and affect the overall cost of services. We expect oil prices to remain elevated in the short term as a result of OPEC+ production cuts, as well as the recent Hamas attack on Israel, which has already caused another spike in prices.
Graph 1: Truflation Core Inflation Measures
On the macroeconomic side, we believe the hiking cycle is virtually complete, but easing will not begin until long into 2024. We have seen encouraging signs that suggest the Fed has reached its terminal policy rate. However, given the strength of the US economy, the tight labor market, and the fact that inflation is still not completely under control, there is little chance of an imminent rate cut and another hike may well be on the cards.
One of the reasons for this is strong economic growth. GDP growth has been accelerating since mid-2022 and consensus estimates for Q3 2023 suggest this will continue, especially given buoyant consumer spending over the summer months despite ongoing erosion of savings, elevated inflation, and growing household debt.
However, we expect growth to materially slow down in 2024. We have witnessed an acceleration in downside risks to economic activity in recent weeks, including the ongoing auto workers strike, the narrowly avoided government shutdown that could still materialize in Q4, and the restart of student loan payments in October. These temporary factors are unlikely to drag the US into recessionary territory, but they will have deeper implications if they persist into 2024.
The continued tightness of the labor market is one factor that could force the Fed’s hand on another interest rate hike. September’s jobs report revealed that the unemployment rate held steady at 3.8%, while the economy added a whopping 336,000 jobs – nearly double what economists had expected. The biggest gains came from the leisure and hospitality, government, and healthcare sectors.
However, signs of softening are emerging here too. August marked a 30bps increase in unemployment from 3.5% to 3.8%, which reflected a 736,000 increase in the labor supply. In turn, this larger pool of available labor puts downward pressure on wage growth. Indeed, this has already begun to tick lower to 5.73% YoY in August. This is consistent with broader wage measures that show easing price pressures including the Employment Cost Index, the Indeed wage tracker, and the Atlanta Fed's wage growth tracker (see below).
In addition, layoff data published in Truflation’s live labor data stream shows that the number of job cuts has tripled from 23,697 in July to 75,151 in August. Similarly, DailyJobcuts.com shows that the number of job cuts has doubled between July and August. All this is evidence that the labor market is finally beginning to cool.
Graph 2: US Wage growth indicators
Source: BLS, Federal Reserve Bank of Atlanta, Macrobond, Swiss Re Institute
Other indicators also suggest that while the near-term growth outlook remains positive, 2024 is likely to post anemic GDP growth. Business loan demand remains weak due to the tightening of bank lending and as a result of several bank failures in March.
On the consumer side, spending has remained strong so far despite rising interest rates. However, household debt is expected to increase further, while delinquencies are projected to rise over the coming months as wage growth slows and rising interest costs drive debt payments higher. Savings rates have also reversed the relentless rise we have seen since late 2022, falling to 3.5% in July, which suggests consumers are dipping further into their savings.
However, the latest business surveys reflect an improvement in sentiment. The ISM manufacturing index rebounded by 1.2 points to 47.6, though it remains in contraction territory. The ISM services index rose 1.8 points to 54.5 – its strongest level since February.
The same cannot be said for consumer confidence, though. Truflation’s Consumer Confidence Index has fallen for the second month in a row, down from 94.5 points in July to 89.7 in September. The Index of Consumer Expectation is also down from 106.8 points in July to 104.2 points in September. This drop in optimism reflects concerns over rising grocery and gasoline costs (though food inflation continues to slow). It is also consistent with the recent dip in labor market conditions, with jobs becoming harder to get and wage increases slowing down.
Graph 3: Truflation Consumer Confidence Trends
Similarly, while retail sales were still rising in September, their annualized rate of growth slowed from 8.7% in January to 2.9% in September, as reported by the US Census Bureau. On an inflation-adjusted basis, the rate is, in fact, declining. In addition, retail inventory remains at its highest level in over two years, suggesting that we are likely to see further downward pressure on retail prices in the coming months.
Graph 4: Monthly US Retail Sales & Inventories in millions of $
Source: US Census Department; Advance Monthly Retail Trade Survey
Overall, while inflation has fallen significantly from over 9% to 3.7%, it remains unclear if we have seen the end of it. As such, the FOMC meeting on November 1 is yet another critical one for the future of US monetary policy.
Last month, the BLS reported continued upward movement in CPI to 3.7% in August. However, September marked a minor reversal in this trend. Market expectations range from 3.5% to 3.7%, and Truflation’s model predicts that inflation will dip to 3.6%.
Truflation’s data reveals that the most significant contributions to higher inflation in September came from gasoline, utilities, other vehicle expenses and other lodgings. Meanwhile, the biggest downward contributors were vehicle purchases and food.
Truflation's mission is to provide the most accurate inflation measurement in the market by leveraging 30+ data sources and over 12 million price points for goods and services. Truflation is not designed to measure BLS numbers as its index is based on just 80,000 items and uses a different methodology from ours. Rather, Truflation represents an alternative data source and one of the most comprehensive inflation measurement tools that can be reliably used to predict the BLS inflation estimate.
Key drivers of upward inflation
The main drivers of inflation are persistent wage growth, higher oil prices, and higher material prices. Consequently, the categories with an upward impact on inflation are owned housing, gasoline, vehicle expenses, and utilities. Prices in the services sector are also holding steady. Together, these drivers are keeping inflation well above the Fed’s 2% target.
In the housing category, price increases have been driven by owned property. The latter is one of the main contributors to September’s CPI, up 0.31% MoM and 2.99% YoY. This strong price trend comes despite several factors that should, in theory, cause a decline in prices.
Firstly, Truflation’s live housing data stream shows demand for new homes has continued to drop. According to the National Association of Realtors, the total number of existing home sales has gradually fallen from 4.3 million in January to 4 million in August. The data also reveals that the average number of houses sold in August has declined by 9% between July and August 2023, to 675,000. Zillow, Trulia and Redfin are all reporting similar consistent trends.
Secondly, interest rates are at historic highs. At the end of August, the 30-year fixed-rate mortgage rate reached a decade-high of 7.49%, according to Freddie Mac. Given the uncertainty surrounding the Fed’s monetary policy plans, these elevated rates are set to hold for some time. Soaring tax premiums have also put pressure on the owned property segment.
Graph 5: Truflation Housing Category Price Trends
And finally, we are also seeing more supply coming onto the housing market, which should drive prices lower. Year-to-date, the number of new residential homes has increased by 6.7% on an annualized basis, to 11.65 million. However, it is unclear how long this situation will last, with higher material costs now beginning to impact the construction industry. As a result of this, new residential building permits and new residential completions are down 17.3% and 13.2% respectively compared to this time last year.
Graph 6: Housing Supply; New Residential Permits, Starts and Completes in 000s of Units
Source: US Census Bureau / New Residential Construction Report (all in 000s of Units)
Overall, though, we are yet to see the real impact of these drivers on the prices of residential homes, which have remained relatively stable and have even shown marginal monthly increases. Furthermore, while we expect high interest rates and greater supply to eventually cool demand and prices, this trend may be short-lived if we see a drop in new supply.
In addition, as corporate America demands that employees return to office work, the owned property segment may see further upward pricing pressure as workers are forced to move back to the cities. However, given the sky-high interest rates, this is likely to impact the rental market first before migration back to the cities begins to impact owned housing.
After owned housing, gasoline prices were one of the key drivers of the CPI’s upward movement in September, having risen 0.61% MoM after a 6.78% increase last month. It is therefore not surprising that this category is up 2.26% YoY and continuing to see an increase.
Gas prices did slide over the summer as a result of various price-stabilization efforts, including a historic oil release from the Strategic Oil Reserve. Now, though, OPEC+ has moved to further cut the global oil supply, which will inevitably lead to another price spike. In addition, the Hamas attack on Israel has already driven oil prices higher as we pen this in the second week of October.
Graph 7: Price of WTI Crude Oil per barrel
82.79 USD/bbl for October 6, 2023
Data Source: Weekly Petroleum Status from the Energy Information Administration
Rising prices of energy commodities, be it gas or oil, have in turn resulted in higher utilities prices. The sector has seen a 1.89% MoM increase on top of a similar increase last month and is up 0.68% YoY. In addition, this September was warmer than usual yet again, contributing to further inflation in this category.
Graph 8: Truflation Utilities Category Price Trends
Other vehicle expenses also remained high in September, up 1.3% MoM and 13.2% YoY. The last six months have seen a pattern of monthly increases amid rising interest rates. With rate cuts unlikely anytime soon, we expect prices in this category to remain elevated. This is also the biggest driver impacting auto loan debt, which has increased by 5% YoY to $1.582 trillion.
The clothing and footwear sector has seen inflation rise by 0.42% MoM and 3.22% YoY. This increase in apparel prices is likely seasonal as consumers prepare for cooler temperatures. In addition, the corporate drive to bring employees back to the office is undoubtedly impacting shopping behavior. This, combined with aggressive price activity in the market to woo consumers, has led to an increase in sales, while inventory levels have remained relatively stable.
Graph 9: Truflation Clothing & Footwear Category Price Trends
Finally, other significant contributors to inflation in September include alcohol & tobacco, up 0.39% MoM and 4.93% YoY, driven by higher tobacco prices; and education, up 0.41% MoM and 3.02% YoY due to the general increase in labor costs.
Categories continuing to apply downward pressure on inflation
In September, three main categories contributed to the continued deflationary trend: food, housing (rented and other lodgings) and vehicle purchases.
Of particular interest is the mixed trend in the housing sector, which makes up nearly a quarter of total household expenditure. While owned housing is seeing inflationary pressures, the rental market is cooling as a result of excess supply coming onto the market. It is typical for the rental sector to reflect this trend first, given the higher rotational impact of increased supply and rental agreements.
The rented market has seen only a marginal increase in prices of 0.13% MoM, but on an annual basis inflation is down 1.75%. The increased supply, combined with the uncertain economic outlook, puts the power in the hands of the renters.
The spike in supply has led to a gradual increase in rental vacancy rates, which have now reached the highest level since June 2020.
Graph 10: US Rental Vacancy Index (%)
Source: Apartment list US vacancy Index (Rate %)
The other lodging category has also seen a monthly decline of 2.72%, driving inflation down to 4.42% YoY. The recent news that Airbnb is expanding from short-term lettings to long-term accommodation and car rentals serves as an example of the difficulties this sector is facing. In addition, New York – a key Airbnb market – recently imposed restrictions on Airbnb short-term rentals. In the longer term, however, this could drive up hotel prices in one of the biggest hotel markets in America.
Meanwhile, the food category has seen a further decline in inflation in September, down 0.46% MoM. However, on an annual basis, prices are still 1.05% higher. The recent price slowdown is evident in both grocery prices (food at home) and the cost of dining out (food away from home).
Graph 11: Truflation Food & Beverage Category Price Trends
The continued slowdown in food prices reflects faltering consumer confidence. In part, this monthly drop can also be attributed to higher competition for the hearts and minds of American shoppers and increased promotional activity in grocery stores. Consumers are also downgrading their purchases in an effort to save.
In addition, recent supply concerns are easing, taking the pressure off certain food items. In particular, the worst outbreak of avian flu in South Africa has hampered supplies but is now petering out.
Today, the average cost of groceries in America is $414 a month per person. However, this varies significantly depending on personal eating habits, location, and the size of the household. Yet despite the relief for struggling consumers from falling food inflation, let's not lose sight of the fact that prices are still up 1.05% YoY on top of last year’s 9.9% annual growth.
The transport sector – for which we also now publish a detailed data stream on the Truflation website – was another key downward contributor to inflation in September. In particular, this is coming from vehicle purchases.
Demand for new and used cars has significantly waned since the early months of 2023. The impact of interest rates on financing costs and excess inventory has placed downward pressure on vehicle prices in the last five months. Auto retail inventory continued to rise from $221.1 billion in June to $222.6 billion in July 2023. As a result, vehicle purchases are down 0.88% MoM and 3.2% YoY. As inventory levels outstrip demand, we expect prices in this category to keep falling.
Graph 12: Truflation Transportation Category Price Trends
On top of this, we have seen significant growth in government subsidies for electric vehicles. EV revenues are projected to reach $70.1 billion in 2023 and grow at a compound annual growth rate (CAGR) of 18% between 2023-2028. EV car sales are being propelled by price cuts, a wider variety of available vehicles, more government and manufacturing investments, and the impact of the Inflation Reduction Act. The latter introduced tax credits of up to $7,500 per electric vehicle, with a recent announcement making it easier and quicker to claim this tax break, while the list of cars entitled to this benefit has expanded.
Graph 13: Motor Vehicle and parts dealers Retail Sales and inventories in Millions of $
Source: US Census Department; Advance Monthly Retail Trade Survey
Other sectors seeing deflationary trends include health, household durables and communication, all experiencing marginally weakening demand. However, the prices of the service elements of these sectors remain elevated due to the continued tightness of the labor market.
Long-term inflation forecast
We believe inflation will remain stubborn and even see a marginal increase in the next couple of months before coming down towards the end of the year. We maintain our year-end projection of 3.5% to 4% for inflation as reported by the BLS.
In the short term, inflation will continue to be driven by the tight labor market and marginal increases in utilities, gasoline and service-based categories.
In addition, with a strong likelihood of one more interest rate hike later in the year and a softening in the labor market as a result of an overheated economy, we expect to see a continued drop in consumer confidence. This, in turn, will bring down prices in the housing category and curb consumer spending, helping to keep inflation in check over the long term.
Truflation provides a set of independent inflation indices drawing on 30+ different data partners/sources and more than 12 million product prices across the US. The indices are released daily, making it one of the most up-to-date and comprehensive inflation measurement tools in the world.
Truflation has been leveraging this measurement tool to predict the BLS CPI number. Since Truflation initiated coverage, four predictions were spot on, with all but one deviating by no more than 20 basis points. However, Truflation’s own US CPI index is currently much lower than the government’s reported inflation figure.