Consumer inflation cooler than expected
Fed on track to cut rates again next week.
Published October 24 2025
Bottom line
Retail inflation in September was slower than expected across the board, which we believe keeps the Federal Reserve on track to cut interest rates again by a quarter point at next week’s policy-setting meeting. Owners’ equivalent rent (OER), which accounts for about 26% of the CPI weight, rose only 0.1% m/m in September, down from increases of 0.4% in August and 0.3% in July, marking the slowest monthly contribution from housing inflation since 2021.
The nominal Consumer Price Index (CPI) rose only 0.3% on a month-over-month (m/m) basis in September, down from a 0.4% increase in August and a tick below Bloomberg’s consensus expectations of a 0.4% m/m gain. The core CPI, which strips out volatile food and energy prices, rose by only 0.2% m/m, down from a 0.3% increase in August and a tick less than consensus expectations for a 0.3% gain.
Nominal CPI rose 3.0% on a year-over-year (y/y) basis in September, which rose from a 2.9% increase in August, but was a tick below consensus expectations for a 3.1% y/y increase. Core CPI also rose 3.0% y/y in September, a tick below August’s 3.1% y/y increase and September’s consensus expectations for a 3.1% y/y gain.
Better late than never The Bureau of Labor Statistics (BLS) delayed the release of this inflation report from October 15 due to the federal government shutdown. But the BLS recalled staff to prepare the report, in large part because it is a critical component in calculating the Social Security Administration’s annual cost-of-living-adjustment (COLA), which goes into effect in January 2026 and is calculated by averaging inflation trends from July, August and September. By law, the federal government must announce next year’s COLA by November 1, which mandated publishing September’s inflation data before the end of October.
Next year’s COLA will rise 2.8%, compared with increases of 2.5% in 2025 and 3.2% in 2024. Over the past decade, it has averaged 3.1%, but that included sizable increases of 8.7% in 2023 and 5.9% in 2022, as nominal CPI inflation spiked from a five-year low of 1.4% in January 2021 to a 41-year high of 9.1% in June 2022. The increase in 2021 was only 1.3%.
The BLS said that it did most of its data collecting for this morning’s September report before the federal government shut down on October 1. Because no data has been collected during October, it’s unlikely that we’ll see an October update, to be released on November 13.
Flying blind At its last policy-setting meeting on September 17, the Fed cut interest rates by a quarter point for the first time since last December, to a target range of 4-4.25%. The central bank decided that the deterioration in the labor market over the past year outweighed the recent uptick in nominal inflation, which had declined from a 41-year high in 2022 to a four-year low in April and May of this year.
Core CPI, for example, has slowed from a peak of 6.6% y/y in September 2022 to 2.8% in each of April and May 2025. While it’s risen to 3.0% in September, the Fed believes that’s a one-time effect related to President Trump’s trade policies, rather than a sustainable surge like the one that drove inflation sharply higher in 2021 and 2022 to four-decade highs.
In its September 2025 Summary of Economic Projections (SEP), the Fed indicated the potential for two more quarter-point rate cuts this year on October 29 and December 10. We at Federated Hermes believe that September’s relatively benign inflation data keeps policymakers on track to execute those cuts. Further, we anticipate three additional quarter-point cuts during 2026, taking the terminal value of the fed funds rate down to 3.0%. Embedded in our forecast is our expectation of a more dovish leadership transition at the Fed, when Chair Jerome Powell’s term expires in May 2026.
Labor market data also delayed The government shutdown also canceled the September nonfarm payrolls report. That makes the Fed’s predictions in its September SEP less dependable. In that, policymakers left their forecast for the unemployment rate (U-3) at year-end unchanged at 4.5% compared with the actual 4.3% in August 2025, which is a four-year high. By comparison, U-3 was at 4.0% in January 2025 and at a 53-year cycle low of 3.4% in April 2023. The Fed is expecting the U-3 to decline to 4.4% in 2026, to 4.3% in 2027, and to 4.2% in 2028.
Energy inflation heading lower? Crude oil (West Texas Intermediate, or WTI) prices have declined 30% this year, falling from $80 per barrel in January 2025 to $57 last week. The US is producing 13.6 million barrels per day due to increased exploration and production activities, and the OPEC cartel has also increased its production in recent months. Gas prices at the pump follow with a lag, and they’ve declined by 7% so far this year, from a peak of $3.27 per gallon in April to a low of $3.04 last week. We could see gas prices approach $2.80 per gallon in coming months.
PCE readthrough? With the September CPI data in hand, the core Personal Consumption Expenditure (PCE) index, the Fed’s preferred measure of inflation, is expected to be unchanged at a 0.2% m/m increase and a 2.9% y/y increase in September. The Fed is expecting core PCE inflation to rise by 3.1% in 2025.
Equity investors remain enthusiastic In the aftermath of this morning’s positive inflation surprise, the S&P 500 rallied to an intraday record of 6,807 before ending at 6,792. Our target for this year remains at 7,000, and we forecast it to hit 7,800 in 2026 and 8,600 in 2027. The combination of stronger economic and corporate profit growth and lower interest rates from the Fed is a powerful elixir for risk assets.
Read more about our views and positioning at Capital Markets.