The latest inflation data is putting renewed pressure on the Federal Reserve to tighten monetary policy further. The Producer Price Index (PPI) for final demand rose 1.3% in September, according to the Bureau of Labor Statistics, marking the largest monthly advance since a 1.7% jump in March 2022. That compares with a 0.4% increase in August and was more than double the 0.6% consensus forecast from economists polled by Dow Jones Newswires and the Wall Street Journal.
On a year-over-year basis, PPI climbed 6.3% in September, up from 5.4% in August and well above the 5.4% expected. This was the biggest 12-month increase since December 2022, when the index rose 6.4%. The core PPI, which strips out volatile food and energy prices, rose 0.7% for the month, after a 0.2% gain in August, and exceeded the 0.3% forecast.
The hotter-than-expected producer prices come on the heels of a similarly surprising consumer price index (CPI) report. Core CPI also ran above forecasts on Wednesday, reinforcing the view that inflation is not cooling as quickly as policymakers would like. For advisors, the data points to a more hawkish Fed than markets had priced in just a few weeks ago.
According to the CME FedWatch tool, the probability of a 25-basis-point rate hike at the October 27-28 Federal Open Market Committee meeting rose to 33.8% after the PPI release, up from 29.3% beforehand. For the December meeting, the odds of a hike to a target range of 4% to 4.25% now stand at 63.2%, with a 30.6% chance of an even larger move to 4.25% to 4.5%.
Chris Zaccarelli, chief investment officer at Northlight Asset Management, said the back-to-back inflation surprises leave the Fed with little room to pause. "With a second day in a row of higher-than-expected inflation numbers, it seems the Fed will have no choice but to raise rates again this year," he said. Zaccarelli does not expect a move at the October meeting, given the proximity of the midterm elections, but he anticipates a hawkish 25-basis-point hike in December.
The inflation outlook is complicated by geopolitical factors. Zaccarelli pointed to the conflict in Iran and the resulting spike in energy prices as a key challenge for the first half of the year, and he noted that the rising rate environment is a new headwind for markets in the second half. "If this market is one thing it is resilient, and we believe that resilience will last through the end of the year," he said, "but we need to get through the uncertainty of the rapidly approaching mid-term elections, and the volatility that this creates, before the market can finish the year stronger."
For financial advisors, the implications are significant. Higher-for-longer interest rates can affect portfolio valuations, client borrowing costs, and the attractiveness of fixed-income investments. The recent record inflows into bond ETFs suggest that investors are already positioning for a more hawkish Fed. Additionally, the Fed minutes from the September meeting signaled that another hike is likely by December if inflation persists.
The PPI report is the latest in a series of economic data points that will shape the Fed's decision. As advisors monitor these releases, they should also keep an eye on the September CPI details, which showed that core inflation remains sticky even as headline numbers are influenced by energy prices. The combination of high producer prices and firm consumer prices suggests that inflationary pressures are broad-based, making it harder for the Fed to declare victory.
In the near term, market volatility is likely to remain elevated as investors digest the implications of another potential rate hike. The Fed's next meeting is scheduled for October 27-28, and while a move is not fully priced in, the odds have risen sharply. For advisors, the key takeaway is to prepare clients for the possibility of higher rates for longer, and to review portfolio positioning accordingly.
