US Core CPI Stubbornly High at 3.2% as Rate Cut Hopes Dim

In August, the US unadjusted core Consumer Price Index (CPI) year-over-year came in at 3.2%, exactly matching expectations and the previous month’s figure. The broader unadjusted CPI for the same period was 2.5%, marginally below the forecasted 2.6% and a significant decrease from the prior 2.9% reading.

Following the release of the CPI data, traders significantly reduced their bets on the Federal Reserve implementing a rate cut. Prior to the data release, market sentiment was already divided on the central bank's next move.

Although there were expectations for CPI to decelerate, particularly core CPI, which excludes volatile categories like food and energy, it remains robust at a 3.2% year-over-year growth. This persistence in core inflation suggests that the Fed might find it challenging to justify a more aggressive rate cut.

Previously, market projections had pegged the chance of a 25-basis-point rate cut at 67%, with the likelihood of a more significant 50-basis-point cut exceeding 30%. Given the observed inflation trends and comparisons with other major central banks like the Bank of Canada and the European Central Bank—both of whom have already enacted multiple rate cuts—the Fed's positioning appears relatively more conservative.

Energy prices, a key contributor to the broader CPI, have shown reductions, with retail gasoline prices in August declining by 3% month-over-month according to the EIA. Diesel and aviation fuel prices have also fallen, indicating a potential contribution to slower CPI growth. Meanwhile, manufacturing slowdown and excess oil capacity are putting further downward pressure on energy prices.

On the other hand, core inflation remains elevated due to robust housing costs. Data from Zumper indicates that rental prices for one and two-bedroom units rose by 0.2% month-over-month in August and are up 2% and 3%, respectively, year-over-year. High demand in the housing market continues to bolster inflationary pressures, evidenced by strong rental markets in major cities and college towns across the US.

The balanced outlook between decelerating manufacturing and rising service costs complicates the Fed's decision-making. The employment market's split performance, particularly the strength in the housing sector within the service industry, challenges the notion of straightforward monetary easing. An unchecked core inflation rate might reignite broader price increases, while too cautious an approach could leave the Fed behind the curve as economic conditions evolve.

Overall, while manufacturing weakness steers the overall CPI closer to the Fed's 2% target, persistent core inflation underscores sectoral divides within the economy. Consequently, these complexities compel the Fed to maintain a cautious stance, making substantial rate cuts appear less immediate as they balance potential economic overheating against premature easing.