US inflation jumps to 3.7% in September as gasoline surges 9.1% in a month

What happened

The Bureau of Labor Statistics said on Wednesday that its consumer price index climbed 0.6% in September after seasonal adjustment, taking the annual rate to 3.7%. Gasoline rose 9.1% over the month and drove more than half of the overall increase, while the wider energy index gained 5.2%. Core prices, which leave out food and energy, rose 0.3% on the month and 2.6% on the year, both a notch above economists' estimates. The Financial Times (FT) reported that the Iran war is behind the jump in prices, adding to the pressure on voters before the midterm elections.

What it means

The headline number is mostly an oil story. Since the US and Israel struck Iran in late February, flows through the Strait of Hormuz have been squeezed and refining capacity in the region has been damaged. Over the past 12 months the BLS energy index is up 20.4%, gasoline is up 34.2% and fuel oil is up 74.2%. AAA data cited by CNBC put the average US pump price at $4.33 a gallon on Wednesday, against $2.98 just before the war began.

The more worrying detail for the Federal Reserve sits beneath the energy figures. Core inflation edged up to 2.6% from 2.4%, and the rise was spread across shelter, used cars, airline fares, recreation and apparel. Economists at RBC noted that toys and other mostly imported recreational goods posted their largest monthly price changes on record, a sign that tariffs and higher transport costs are feeding into shop prices. Fuel shocks are usually treated by central banks as temporary, but the longer they last, the greater the risk that they seep into wages and expectations.

Food was a small relief. The food index was flat in September and grocery prices slipped 0.1%, helped by a 1% fall in beef. Diesel, which moves goods by truck, train and ship, is another matter: AAA put it at $6.30 a gallon, roughly 68% above its pre-war level, and economists told CNBC those costs tend to reach consumers with a lag of a few months.

Markets moved quickly to price a more aggressive Fed. After the report, futures traders put the chance of a hike at the October 27-28 meeting at about 54%, according to CME Group's FedWatch tool, and saw a better than 96% chance of a rise before year end. The Fed raised rates in September for the first time in more than three years, to a range of 3.75% to 4%. The 10-year Treasury yield rose about 9 basis points to roughly 5.31%, CoinDesk reported, while bitcoin and gold fell.

The bull case

Much of the jump came from one volatile item. Gasoline alone accounted for over half of September's rise, and energy shocks tend to fade once supply recovers. Grocery prices fell on the month, and core inflation at 2.6% is still well below the headline figure. If shipping through Hormuz improves, the headline rate could cool without the Fed needing to tighten sharply.

The bear case

Core inflation surprised to the upside for a reason that goes beyond fuel, and diesel costs have yet to fully pass through to store shelves. A second Fed hike, possibly as soon as October, would push borrowing costs higher just as Treasury yields sit above 5%. That combination could weigh on stock valuations, housing and consumer spending, which was already showing strain in weak sentiment surveys.