September inflation comes in hotter than expected, raising odds of Fed rate hike this month

September's inflation report landed hotter than Wall Street expected on nearly every measure, and the Federal Reserve's next meeting is now just two weeks away. The Consumer Price Index rose 3.7% year over year — above the 3.6% forecast and up from 3.4% in August — while the monthly headline gain of 0.6% also beat expectations of 0.5%. But it was the breadth of the underlying data that caught economists' attention.

Core CPI, which strips out volatile food and energy prices and is the measure Fed officials watch most closely, rose 0.3% month over month — holding the same level as August and above nearly all Wall Street forecasts, according to reporting. The year-over-year core rate came in at 2.6%, above the 2.5% forecast and up from 2.4% in August. That pushed the three-month annualized rate for core inflation higher, according to reporting.

A surge in gas prices — up 9.1% in September — accounted for more than half of the headline monthly increase, with the broader energy index rising 5.2% after a 2.1% gain in August. But the core reading told a more complicated story: toy prices posted their largest-ever monthly rise, jumping 4.2%; used vehicle prices rose 0.7%; apparel gained 0.3%; and shelter costs climbed 0.4%, driven by a 2% jump in lodging prices and firmer gains in primary rent and owners' equivalent rent, according to Yahoo Finance.

The upside surprise to core CPI in September was broad-based rather than due to any obvious temporary factors, therefore bringing an October rate hike back into play and presenting upside risks to our forecast for just two more 25 bp hikes from the Fed.— Stephen Brown, Chief North America Economist, Capital Economics

Before Wednesday's report, futures markets put the odds of a rate hike at the Fed's October 28 meeting at roughly 20%. After the data dropped, that figure rose to 43.7%, according to CME Group data cited by Yahoo Finance. Markets are pricing better than 50% odds of a second hike this year at the December meeting. The yield on the 10-year Treasury crested above 5.3% Wednesday morning.

Fed officials are not speaking with one voice. Governor Chris Waller said earlier this month that he anticipates additional hikes to support a timelier return to the 2% inflation goal, while leaving flexibility on timing. Speaking Monday, Cleveland Fed President Beth Hammack described inflation as broad-based and slow to recede, and said she prefers making rate adjustments in smaller, more frequent increments to keep an inflationary mindset from becoming entrenched.

If the economic data continue to come in as expected, I anticipate additional hikes to support a timelier return of inflation to our 2% goal. But there is some flexibility about when those hikes will occur. The hikes do not need to come at consecutive meetings, but they should be in place in an acceptable period of time.— Chris Waller, Federal Reserve Governor

Fed Vice Chair Philip Jefferson and New York Fed President John Williams, by contrast, have pulled back expectations for a move in October. In a Tuesday interview with Bloomberg, Williams said he still considers one additional rate hike appropriate this year but does not think the Fed will need to raise rates again in 2027.

Inflation pressures are broadening beyond energy, suggesting the last mile back to target could remain bumpy and keep interest rates elevated. The latest report complicates the Fed's decision this month, as the road back to price stability is looking increasingly difficult to navigate.— Jeffrey Roach, Chief Economist, LPL Financial

Roach added that for the Fed to reasonably conclude inflation pressures are contained, monthly core inflation must consistently come in between 0.1% and 0.2% — a threshold that September's 0.3% reading missed by a wide margin.

Brown of Capital Economics estimated that the broad-based move in core CPI will likely show up in the Fed's preferred inflation gauge — the core Personal Consumption Expenditures index — which he placed at roughly 0.32% for September. If accurate, that would cause the three-month annualized core PCE rate to rebound to 2.8% from 2% in August, potentially giving Fed officials enough cover to act this month.

Not everyone thinks October is the right moment to move. Christopher Hodge, chief economist at Natixis, argued that pausing in October would allow more time to assess economic data before the December meeting, and would avoid the political optics of raising rates just before midterm elections in early November.

Ultimately, we think the Fed will pause when it meets in a few weeks, but today's data at least gives the hawks more ammo, and if markets continue to price in a hike, the FOMC may be loath to surprise with a hold.— Christopher Hodge, Chief Economist, Natixis

Wednesday's report extends a streak that has become one of the most persistent inflation episodes in modern U.S. history. CPI has now registered above 2% for approximately 65 consecutive months — more than five years — the longest such run of the 21st century, according to a CNBC analysis of Bureau of Labor Statistics data. Only twice before, going back to the late 1940s, has the U.S. sustained a longer period of inflation above 2%. Since inflation began running above 2% in early 2021, the average CPI reading has sat around 4.5%; a streak carrying a mean that high had not been seen since one that ended in the 1980s.

The prolonged run of high prices is reshaping consumer behavior in ways that worry Fed officials. According to the New York Fed's Survey of Consumer Expectations, the one-year inflation outlook climbed three-tenths of a percentage point in September to 3.9%, its highest level in more than three years. Cleveland Fed President Hammack warned that with each month inflation comes in high, the risk grows of an 'inflationary mindset' becoming entrenched.

They're starting to accept high inflation as just a fact of life. That's concerning.— Beth Hammack, President, Cleveland Federal Reserve

Inflation is like a cancer, and if you let it metastasize and go further, it's even worse. Even when the cure hurts, it's better than letting it metastasize.— Diane Swonk, Chief Economist, KPMG

The next firm signal on the Fed's direction will likely come from upcoming remarks before the quiet period begins. After that, the October 28 meeting will deliver the verdict.

Why it matters — With inflation still running well above the Fed's 2% target after more than five years, Wednesday's report raises the real possibility of a rate hike as soon as October 28 — meaning higher borrowing costs for mortgages, car loans, and credit cards could arrive sooner than markets had expected.

Reported by x.com, wsj.com, moneycontrol.com, reuters.com, finance.yahoo.com, cnbc.com, axios.com