Cool Enough CPI Report Paves Way for a Dovish Cut on Wednesday

• News that China and the US have agreed to a series of trade-related deals, in anticipation of a Thursday meeting between Trump and Xi, has risk markets heading higher as Treasuries back up a bit on the positive news. The devil always lurks in the details of these grandiose announcements, but for now the market is taking the positive at face value. Currently, the 10yr Treasury is yielding 4.02%, up 2bps on the day, while the 2yr note yields 3.50%, also up 2bps in early trading.

 

• Friday’s September CPI was about as good as the Fed could have hoped for with the always critical piece, Owners’ Equivalent Rent, dipping to a four-year low and core goods prices showing no outsized effects from tariffs. Even core services played nice so in all, worries over excessive inflation have abated near-term and that allows the Fed to cut on Wednesday, as expected, but also provide a tone that additional cuts (read December) will be coming given the easing in labor market momentum and the sudden appearance of credit concerns.

 

• Now that’s not to say monetary hawks on the committee won’t have their concerns. Year-over-year inflation rates, both overall and core, at 3.0% remain 100bps above the 2% target, but the trend is one of stabilization and not incremental increases and that will allow a longer runway for rate normalization. With futures at 95% odds of a second cut in December, the focus turns towards how many cuts can be expected in 2026.

 

• Right now, futures markets see fairly equal odds the funds rate finishes 2026 at either 2.75% – 3.00% or 3.00% – 3.25% implying another two or three 25bps cuts next year.  That’s not an unreasonable expectation, especially if credit concerns continue to build.

 

• We will add, however, that while BLS staff were called back to complete the report, it was more to do with finalizing the fiscal year-end CPI data that determines the Cost-of-Living Adjustments (COLA) for Social Security Payments beginning in January. To that end, the SSA was quick to publish that the COLA increase in payments beginning January will be 2.8%. That means the average monthly payment will increase by $58. Also, the maximum income subject to SSA tax will increase from $176,100 to $184,500 beginning in January.

 

• We’d be remiss if we didn’t add that while BLS staff completed the September CPI report, the level of data collection and analysis was not up to the usual standards (i.e., it wasn’t an all-hands-on deck call back). One area that requires a lot of on-the-ground data collection and analysis is the critical Owners’ Equivalent Rent component. With limited staffing we’re assuming there were more assumptions built into the September number than is usually the case. So, while the result was surprisingly below trend and beneficial to the overall cool results, one has to wonder if a typical BLS staffing effort would have generated a similar outcome.

 

• In that regard, it’s being reported that 40% of CPI line items were based on imputation, meaning data collectors had to fill in missing data by using values from related but different categories or geographic areas (see graph below on “cell imputation). Thus, it could be that this report is treated with something of a jaundiced eye. The good news, perhaps, is that OER is definitely rolling over and with ongoing weakness in rental prices due to easing demand and increased supply, it should continue to be a favorable input into inflation calculations in 2026. We should add the caveat, however, that OER as explained above is one of the more labor-intensive pieces as it uses rental and value surveys extensively, so it seems likely “cell imputation” was a key piece for the September result.

 

• So, while the data blackout continues, we at least have the Wednesday FOMC rate decision to provide some diversionary interest. While this is not a quarter-end meeting with updated rate and economic forecasts (that will come with the December meeting), we hold out hope that Chair Powell’s press conference will provide more insight into Fed thinking than the normally close-to-the-vest commentary that we’re accustomed to.

 

• Also on Friday, the S&P Global released its “flash” PMI readings for October and US business activity growth accelerated in October to the second-fastest so far this year. The headline Composite Index rose from 53.9 in September to 54.8 in October, (based on about 85% of usual survey responses). The latest reading is the highest since July and signals an acceleration of growth to a pace just above the third quarter average. Output has now risen continually for 33 months. The service sector continued to report especially robust growth, posting the fastest expansion since July and the second-strongest increase so far this year. Inflows of new orders for services likewise improved, rising at the steepest rate seen in 2025 to date. While service providers reported signs of improving domestic demand, exports of services fell back into decline after modest growth in September.

 

• Chris Williamson, Chief Business Economist at S&P Global Market Intelligence: “October’s flash PMI data point to sustained strong economic growth at the start of the fourth quarter, with business activity picking up momentum across both manufacturing and services despite some reports of businesses being adversely impacted by the government shutdown. The survey data are consistent with the economy expanding at a 2.5% annualized rate in October after a similar rise was signaled for the third quarter. “However, business confidence in the outlook for the coming year has deteriorated further and is at one of the lowest levels seen over the past three years as companies worry about the impact of policies, most notably tariffs. Companies are also concerned over disappointing export sales, especially in manufacturing, and factories are seeing an unprecedented rise in unsold stock. Having bought excess inputs earlier in the year to front-run tariffs, producers are making more goods to use up these inputs but are often struggling to sell the end product to customers. “Hence, although input costs continued to rise sharply again in October, principally reflecting the pass-through of tariffs, average selling price inflation has cooled to the lowest since April as firms compete on price to win sales.”

 

• Finally, in Argentina on Sunday, with nearly 99% of votes counted, President Javier Milei’s Freedom Advances party won almost 41% of the national vote, more than doubling its representation in Congress. That means his party and allies secured at least one-third of the seats in both chambers—the critical threshold that allows Milei to preserve his veto power and defend his sweeping decrees. It also keeps the US $20 billion swap line in place to help stabilize the peso and aid in the inflation fight. Trump had commented that a loss by Milei’s party would imperil US assistance, but the win has buoyed markets that US assistance will stay in place.

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Estimates vs. Direct Observation in BLS Inflation Reporting Hitting New Highs

 

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Futures have over 95% Chance for Another Cut in December

Source: CME Group

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Futures See Near Equal Odds of Another 2 or 3 Cuts in 2026

Source: CME Group

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   S&P Global Flash Composite PMI – Improves in October