Markets now see no hike in October, but inflation is still a major concern

US inflation has returned to the spotlight after the latest Consumer Price Index (CPI) and Producer Price Index (PPI) reports showed a significant acceleration in price pressures. The data raised concerns that the Federal Reserve may need to maintain restrictive monetary policy for longer, pushing interest-rate expectations higher and putting pressure on stocks and gold.

However, comments from Fed Chair Kevin Warsh on Friday, October 16, helped ease some concerns about an immediate rate increase, offering markets temporary relief.

US CPI: Inflation accelerates to 3.7%

The latest CPI report showed that US headline inflation increased to 3.7% year over year in September, up from 3.4% in August. Monthly inflation accelerated to 0.6%, compared with 0.4% previously.

Energy prices were the main driver. Gasoline prices surged 9.1% during the month, while the broader energy index rose 5.2%. Meanwhile, core CPI, which excludes food and energy, increased to 2.6% annually from 2.4% in August. Monthly core inflation remained at 0.3%.

The figures suggest that energy prices are contributing significantly to inflation, partly reflecting geopolitical tensions and disruptions in energy markets. However, the increase in core inflation indicates that underlying price pressures remain a concern.

US PPI: Producer prices deliver another warning

The Producer Price Index provided further evidence of mounting inflationary pressures. In September, headline PPI increased 1.3% month over month and 6.3% year over year, with the annual increase reaching its highest level since December 2022.

The PPI report is particularly important because it measures prices received by producers and can provide an indication of future consumer-price pressures.

When businesses face higher production costs, they can either absorb them, reducing profit margins, or pass them on to consumers, potentially pushing CPI higher.

The combination of rising CPI and PPI has therefore intensified concerns that inflation could remain elevated for longer than expected.

This data raised the possibility of another rate hike, as policymakers face pressure to prevent inflation from becoming entrenched.

Kevin Warsh’s comments ease market concerns

On Friday, October 16, Warsh indicated that developments since the September meeting had broadly followed the Fed’s expectations. He also stressed that he would not prejudge future policy decisions.

Markets interpreted his remarks as a signal that the Fed might not need to react immediately to the latest inflation figures.

Consequently, the probability of an October rate increase declined to around 15% by Friday according to the CME FedWatch Tool. 

Stocks and Gold face pressure. Treasury yields rise

Higher interest-rate expectations generally weigh on equities because they increase the discount rate applied to future corporate earnings.

Growth-oriented companies, particularly technology and AI-related stocks, are especially sensitive because much of their valuation depends on expected future profits.

Higher borrowing costs can also discourage investment, increase debt-servicing expenses and reduce consumer spending.

Following the CPI release, the Nasdaq Composite fell approximately 1.9%, while the S&P 500 declined around 1.1%. Technology and semiconductor stocks were among the main areas of weakness.

Warsh’s comments subsequently provided some relief by reducing concerns about an immediate rate increase.

Gold is caught between inflation and interest rates

Gold faces conflicting forces. On one hand, persistent inflation increases demand for gold as a store of value.

On the other hand, higher interest rates increase the opportunity cost of holding gold because the metal does not generate interest income. Rising Treasury yields and a stronger US dollar can therefore weigh on gold prices.

Gold prices fell approximately following the CPI report, settling around $4,084 per ounce. However, Warsh’s comments offered some relief by reducing expectations for an immediate rate increase.

What to expect next?

The biggest challenge for the Fed is that inflation is accelerating while employment growth remains subdued. The US economy added just 29,000 jobs in September, highlighting the potential tension between controlling inflation and protecting economic growth.

Three scenarios are particularly important:

• Inflation remains elevated: The Fed would consider further rate increases, putting pressure on stocks and gold while supporting Treasury yields and potentially the dollar.
• Inflation cools gradually: The Fed may be able to delay further tightening, potentially supporting equities and gold if yields and the dollar decline.
• Inflation stays high while employment weakens: The Fed faces a difficult trade-off, while markets could experience greater volatility as investors reassess both growth and monetary policy.

The next CPI and PPI releases, employment figures and Federal Reserve communications will be crucial in determining which scenario becomes more likely.