Inflation is heating up

Two inflation reports in two days. Both hot. The Fed's preferred gauge is next.

Wednesday's CPI showed headline inflation at 3.7%, above the 3.6% expected, with core CPI up 0.3% on the month and 2.6% on the year. Gasoline did most of the work on the headline, but economists noted that price pressures are broadening beyond energy, with shelter, core goods and airfares all firming.

Thursday's PPI was the bigger shock. Producer prices jumped 1.3% in September, more than double the 0.5% forecast, pushing the annual rate to 6.3%. The part I'd watch most: core PPI rose 0.7% on the month versus 0.3% expected, and 5.0% year over year. That's not just an energy story.

What it means for core PCE

PCE is what the Fed targets, and it leans on PPI components (airfares, portfolio management fees, healthcare) that CPI weights differently. Capital Economics estimates core PCE rose about 0.35% in September. A 0.35% monthly print annualizes to roughly 4%, nearly double the 2% target. The September PCE release is due later this month, and these two reports point to an upside surprise.

What it means for the Fed

• October 28: futures implied roughly a 27% chance of a hike at the close on Oct 15, and CME FedWatch had it near 34% after the PPI. I read this as a hold with a live tail risk. The Fed just hiked in September, and the market didn't treat the PPI as a signal to move again right away.

• December: FedWatch put a hike at about 63%. That's where the data lands. If core PCE confirms a 0.3%+ monthly run, and the October CPI (due Nov 10) doesn't cool, December becomes the base case.

  
  

The bottom line

The Fed can look through an energy spike. It can't look through core PPI at 5% and core CPI moving the wrong way for months. The question is no longer whether energy is the culprit. It's whether second-round effects are showing up in core prices, and this week's data says they are. What may have changed is the link between long term rates and the Fed actions. The U.S. 10 year bond has come down to 5% from 5.30%, while inflation is getting hotter. The curve might be flattening short term, but it may be premature to put on duration bets.

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