The US economy remains resilient, but the cost of its strength is becoming increasingly steep. Inflation is heating up at every stage, forcing the Federal Reserve to tighten monetary policy. The Fed has already begun raising rates, with a total of 75 basis points of tightening expected by the end of Q1 2027. However, the pace of hikes has slowed, giving the Fed more time to assess the impact of higher rates, particularly as the resolution of the Iran conflict is seen as key to cooling supply-driven inflation.
The unemployment rate ticked up to 4.2%, though alternative measures of unemployment held steady or improved. The real challenge lies in inflation, with risks rising and elevated bond yields posing broader challenges. Businesses and governments face higher debt-servicing costs, and households taking on new debt feel the impact first. The Consumer Price Index (CPI) delivered an uncomfortable upside surprise in September, with core inflation rising 0.3% month-over-month and the year-over-year pace re-accelerating to 2.6%.
Supply chain and transportation cost pass-through is the top risk to goods price acceleration. Freight costs remain exceedingly elevated, with deep-sea freight costs surging 37% year-over-year, general freight trucking up 17%, and air transport of freight up 6%. Import prices excluding petroleum climbed 0.8% month-over-month, indicating that inflation is spreading beyond energy. Tariffs and import inflation remain a problem, with toys and recreational goods recording their largest-ever monthly CPI increases in September.
The growth outlook remains positive, with underlying growth slightly above the 2% trend. AI continues to drive business investment, while consumer purchasing power is eroded by headline inflation. The labor market is expected to remain tight, with the unemployment rate giving the best gauge of labor market health at 4.2%. However, retirements have driven the unemployment rate lower recently, and a reversal of this trend could lead to a slight uptick in the unemployment rate.