Cooling inflation offers relief amid US data blackout

Amidst an economic data blackout caused by the US government shutdown, markets received a bit of positive news on Friday with the release of the US CPI report which showed consumer prices in September increased at a slower pace than expected. The report, originally scheduled for October 15th but delayed by the ongoing shutdown in Washington, showed headline inflation rose 0.3% last month, which drove the annual rate of inflation from 2.9% to 3.0% but was lower than the 3.1% that markets expected. Importantly, core inflation rose 0.2% in September, the slowest pace in three months and slightly lower than the 0.3% market consensus. Digging into the details, we highlight a few takeaways below.  

Firstly, the data continues to show evidence of tariff passthrough, with those goods that are more heavily exposed to tariffs accelerating the most. This is particularly apparent in categories like apparel, household furnishings and motor vehicles, where prices increased the most in September, whereas prices in those areas less exposed to tariffs increased at a slower rate or in some cases even decreased during the month. In other words, while core goods prices remain firm and US duties might continue to put upward pressure on prices, the inflationary impact of tariffs on the overall goods basket seems to be more subdued than markets originally anticipated.

Looking at the services component, prices gained by the smallest amount in four months as shelter continued its downward trend with the Owners’ Equivalent Rent (OER), which accounts for roughly a quarter of the overall basket, rising 0.1%, its slowest pace since 2020, while primary rent inflation continued moderating after the August spike. Looking ahead, while next month’s OER print may show a small reversal and accelerate from this month’s figure, we would expect shelter inflation to continue its downward trend in coming months as the data from new leases, which has shown signs of slowing down in recent months, flows through to the official statistics.

As for the Federal Reserve, which will be holding its October meeting on Wednesday, we think this print is just good enough and paves the way for the committee to move forward with a second consecutive 25 basis points (bps) interest rate cut, with the Fed currently focused on the employment side of the mandate, given the recent signs of a weakening labour market. Market reaction to the data was also positive with risk assets rallying, with the S&P 500 moving 0.8% higher to close at a record high. Credit spreads tightened, with both CDX HY and Xover indices closing 4 bps tighter.

The reaction in Treasuries was interesting. The curve remained little changed on Friday after the release and is selling off a few basis points as we write on Monday morning. This behaviour highlights that a lot is already priced in in the Treasury curve at this stage. If going forward inflation is not a major issue beyond a short-term impact due to tariffs and growth does not take a significant hit (both of which would be consistent with what the Fed and markets anticipate), then the Fed should cut rates and take them to neutral. This is already priced in, and therefore further sustained rallies in Treasuries from here would require a deviation from this scenario, most likely via lower growth. With Bloomberg consensus for 2025 growth continuing to move higher, this scenario looks increasingly less likely.

While we continue to expect that further impact from tariffs will put upward pressure on prices over the next few months, we take some comfort in the latest data which reinforces our view that longer-term inflation expectations remain well anchored. With fundamentals in corporates and financials still robust, highlighted by the latest earnings season, in which 87% of S&P 500 companies have reported earnings ahead of estimates, a Federal Reserve willing and in position to support the economy, and all-in yields still at historically attractive levels, we continue to think the current environment favours fixed income, and in particular high quality credit given the attractive yields on offer.