US inflation is not the problem I expected it to be
The Federal Reserve raised rates on Wednesday for the first time since 2023, yet the consumer price figures behind the decision show a headline rate stuck at 3.4% and a core rate at its lowest since 2021. With the Strait of Hormuz still contested and the Nasdaq four months into a holding pattern, here is how I read it.
Something that came out of looking at the figures around Wednesday's Federal Reserve decision is that inflation in the United States isn't yet the problem you'd expect it to be. That runs against what you might assume with energy prices where they've been in recent months, but it lines up with what the energy futures markets have been telling us for a while.
The Federal Open Market Committee voted 12 to 0 to lift the federal funds rate by a quarter of a point to a range of 3.75% to 4.00%. It's the first increase since July 2023 and a reversal of the three cuts made through the back end of last year. Inflation was described as elevated relative to the 2% goal, and the new dot plot showed 16 of the 18 participants pencilling in at least one more hike this year.
The move was fully priced, and the reaction was muted. The S&P 500 fell 0.4% on the day and the Nasdaq 100 closed near enough flat.
The figures
Headline consumer price inflation was 3.4% year on year in August, unchanged from July. The monthly rise was 0.4%, up from 0.1% in July, and the gasoline index alone accounted for more than a third of it. The core rate, which strips out food and energy, came in at 2.4%, down from 2.5% and the lowest reading since March 2021.
These aren't terribly high figures. Headline is 1.4 percentage points above target, but it's the same 3.4% we were at in December 2023 and April 2024, and it's come down from a peak of 4.2% in May when the Hormuz closure fed straight through to the pump.
The Federal Reserve's preferred measure is the personal consumption expenditures price index, and it tells a slightly less comfortable story. July, the latest month available, had headline at 3.7% and core at 3.3%, both unchanged from June. The August figure is due on 1 October.
The difference between the two core measures, 2.4% on the consumer price index against 3.3% on personal consumption expenditures, is unusually wide. The personal consumption expenditures basket carries a lower weight on shelter and a higher weight on healthcare and financial services, and those are where prices have kept rising. I'd keep that in mind before concluding the Federal Reserve has moved without cause. It's the 3.3% they are looking at, not the 2.4%.
What is driving the 3.4%
The Bureau of Labor Statistics publishes the arithmetic behind the headline number. Of the 3.4 percentage points, energy contributes 1.08 points, and gasoline on its own contributes 0.87 points. Energy is about 7% of the basket yet it's supplying just under a third of the inflation.
Energy prices were up 16.3% on the year, with gasoline up 27.4% and fuel oil up 52.0%. Take those out and the remaining 93% of the basket is running at roughly 2.5%, which is about where it was before the war started.
| Component | Weight in basket | 12-month change | Contribution (pp) |
|---|---|---|---|
| Food | 13.5% | 2.7% | 0.36 |
| Energy | 7.3% | 16.3% | 1.08 |
| of which gasoline | 3.8% | 27.4% | 0.87 |
| All items less food and energy | 79.1% | 2.4% | 1.95 |
| of which core goods | 18.8% | 0.7% | 0.13 |
| of which core services | 60.3% | 3.0% | 1.82 |
| All items | 100% | 3.4% | 3.40 |
Shelter, the biggest single item, rose 3.0% on the year and is still edging lower. Core goods were up just 0.7%. Used cars are 2.3% cheaper than a year ago.
There's no broad-based price pressure in here. There's an energy shock sitting on top of an economy that was otherwise heading back towards target.
The energy markets
This is the part I find surprising. The Strait of Hormuz has been closed or contested since March, the memorandum signed on 17 June to reopen it collapsed within weeks, and last week Saudi Arabia's East-West pipeline, the main route around the strait, was hit by drones. Brent went back above $100 on 9 September and was trading around $102 to $104 this week. Gasoline hit a Labor Day record of $4.15 a gallon.
Yet the futures curve isn't pricing this as a lasting problem. The forward market is in steep backwardation, meaning later delivery months are priced well below spot prices. Goldman Sachs has Brent at $85 for December and $80 for 2027, and the Energy Information Administration's latest outlook has Brent averaging $87 across 2026 with Middle East output back near pre-conflict levels early next year. The people who price oil and gas futures for a living are heavily researched and I'm not trying to second-guess them. Their curve says the spot price is a premium for disruption, not a new level.
Energy is 7% of the basket and a third of the inflation. Everything else is running at about 2.5%.
If they are right, the energy contribution to inflation starts to unwind mechanically from here. Gasoline was up 21% in March alone, so from March 2027 the base effect turns sharply favourable, and a spot price anywhere near the forward curve would take the energy component negative on a year-on-year basis.
The Nasdaq
The Nasdaq has been in a holding pattern since May. That's four months without meaningful progress, and the composite is sitting roughly where it was before the May inflation print took the headline rate to 4.2%.
It seems to me there is a reasonable chance we break out of that. Inflation isn't as bad as it could be. The Federal Reserve has now done the hike everybody expected, and the market absorbed it without much fuss. On the AI side there is a lot moving, and the capital investment numbers coming through from the large technology companies remain very significant. The Federal Reserve's own statement described productivity growth and capital investment as strong.
Put those together and I think there are some reasonable factors that could see upward momentum in the coming months.
The risks
That view is countered if energy prices do rise again, and they will if there is no conclusion to the Iranian crisis. Brent at $120 rather than $85 changes this argument somewhat, giving the Federal Reserve reason to keep raising.
My feeling is that we are likely, one way or another, to get closer to an Iranian crisis resolution after the midterm elections on 3 November.
The Iranian foreign ministry has said the strait won't fully reopen while the American naval blockade continues, and Washington has said it will rely on the blockade rather than more strikes. That's a standoff, not a war of escalation, and I think this standoff will de-escalate when the political calendar allows.
There's a second risk closer to home for the Federal Reserve, which is that the personal consumption expenditures measure keeps printing 3.3% on core while the consumer price index drifts lower. If that gap doesn't close, the committee will keep tightening into an economy that added no jobs in July and has unemployment at 4.1%. Eight of the eighteen members already see the funds rate higher again in 2027.
My view
Inflation in the United States continues not to be as bad as I initially expected. The headline number is being held up by one component, that component is priced by the futures market to fade, and the rest of the basket is behaving. The Federal Reserve has hiked because its preferred gauge says it should, and it sees it as beneficial to be ahead of a potential need to hike rather than be forced into more dramatic action later on.
For the Nasdaq, the combination of an inflation rate that's stopped rising, a rate decision that's out of the way, and an AI investment cycle that hasn't slowed, gives me more reason to look for a break higher out of the May-to-September range than a break lower. The thing that would change my mind is the oil price, and the thing that would change the oil price is what happens next in the Gulf.