What the latest US inflation number suggests

Key points: 

• September’s US Consumer Price Index (CPI) number was above market expectations
• Inflation was lower than August and suggests momentum is decelerating
• We are starting to see value in all-maturities inflation-linked bonds

US CPI number was above market expectations for September although, at 8.2%, was still lower than the August number. This higher-than-expected figure was driven by upside surprises in services prices, in particular shelter which made up 40% of the upside in core inflation.

Services inflation is more closely linked to domestic activity and shelter was not alone in having strong inflation numbers: medical care and transportation services (bus, train & plane tickets) was also up for the month.  Looking at other contributors, energy prices were lower however food prices were strong. There was some good news to the number as goods inflation was 0% on the month suggesting that Covid inflation is going away.

The September US CPI number confirms our scenario that inflation will be sticky although it is still likely to decelerate in the coming months. Looking at 3-month annualised core inflation measures tends to confirm that while still too hot, inflation momentum has been decelerating (blue line is core inflation, green line is core inflation less shelter – both are 3-month annualised).

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 Source: AXA IM, Bloomberg, 13/10/22

Looking forward, a number of advance indicators suggest that inflation pressures should be easing however there are still some risk areas:

• Goods prices are likely to slow as indicated by a decrease in global supply chain pressures, which were down in September making it the fifth consecutive month of easing.
• Services prices to remain hot because of CPI calculation methodology that has a lot of lags. Shelter, the largest contributor to core, is calculated with a meaningful lag as is medical care inflation. These, therefore, may soon become a drag on the overall CPI number
• Commodities prices do remain an upside risk especially with the recent cut in oil output by OPEC+

Overall, our outlook for slowing inflation remains intact. We believe that we are close to the peak in real yields as inflation seems past the peak in the US and the Federal Reserve should be in a position to become less hawkish in the coming months.

We feel that real yields have reached an end of cycle level and inflation breakevens are consistent with the Fed’s inflation target. All-maturities inflation-linked bonds should be a solid investment in a late phase of the economic cycle because inflation is high so inflation indexation is good.  They are more volatile than short duration, but for investors able to tolerate this volatility, it may be a strategically good moment to consider all-maturities in order to take advantage of this end of cycle projection.