Room to Stay Patient

• The average price for a gallon of gasoline slipped about 1% in October.

• Regional Fed prices-received data showed services cooling last month.

• That should give the Fed room to stay on hold.

The fuel tailwind behind inflation is fading, and that buys the Fed some time...

This week delivers another key test for investors tracking the Federal Reserve's monetary policy outlook. Today, the U.S. Bureau of Labor Statistics ("BLS") will release its October Consumer Price Index ("CPI"). After September's hot print, Wall Street wants to know if inflation is still accelerating. I don't think it is.

According to the Energy Information Administration ("EIA"), the average gallon of gasoline cost $4.45 last month. Based on my calculations, that's down 0.9% from September's $4.49. It snapped two straight monthly increases. Prices are still up about 52% since January, but the climb has stalled...

As the chart above shows, the first half typically produces the bulk of the price growth for the year. October is usually when the relief shows up.

• Gas prices have fallen an average of 2.7% in October since 2000.

• The Cleveland Fed's staff projects headline CPI will hold at 3.7% in October, matching September.

• Core CPI, which strips out food and energy, is seen easing to 2.5% from 2.6%.

Because gas fell less than it usually does, the Cleveland Fed still sees a 0.2% monthly gain. But year over year, inflation looks flat to lower. The Fed held rates at 3.75% to 4% last month, with Beth Hammack and Lisa Cook dissenting for another hike. Chairman Kevin Warsh called inflation too high but said progress is encouraging. Futures leaned toward a December hike. A flat October print gives the Fed room to stay patient at its December 8-9 meeting.

But don't take my word for it, let's look at what the data's telling us...

To get an idea of what inflation growth might look like each month, I built a gauge using monthly manufacturing and services index data from the Dallas, Kansas City, New York, and Philadelphia Fed districts. These surveys ask businesses whether activity is rising, falling, or holding steady. Together, these regions represent roughly 32% of national economic output. I focus on the "prices received" components because they serve as a proxy for CPI.

Each district is weighted by its contribution to national growth, giving us a cleaner read on how they influence the overall picture.

• In October, the combined manufacturing prices-received index came in at 29.4.

• That's up from 28.6 in September but still below the May peak of 31.3.

• It marked a second straight monthly gain.

Manufacturing accounts for about 10% of domestic output. Services matter more. That sector includes healthcare, education, finance, and hospitality - the parts of the economy where most Americans work and spend.

• My gauge shows the services index eased to 22.8 in October.

• That compares to 23.7 in September, the highest reading since early 2023.

• It's still above April's 20.5 peak, but the momentum has turned.

Next, I blended the two measures, weighting them by economic importance and their relevance to CPI. Because services dominate the U.S. economy, they carry more sway in the combined reading.

• The composite came in at 25.1 for October.

• That compares to the recent peak of 25.6 in September.

• It's the first decline since August.

This matters because services are where inflation gets sticky. Manufacturers are still passing along this year's fuel costs, which likely explains the firmer factory reading. But services, the bigger slice of CPI, are starting to cool. Companies are still raising prices, just not as quickly. That lets the Fed wait rather than act.

So, the last step is to measure the Fed's interest rate cushion. We can do this by looking at the real rate of interest (effective federal funds rate minus inflation). A positive number means policy is weighing on price growth, while a negative number means rates are stoking inflation. According to the most recent figures, policy is restrictive enough to hold...

In October, the effective federal funds rate averaged 3.9%, while September's CPI came in at 3.7%. That puts policy about 20 basis points above the so-called neutral level, where rates neither help nor hinder growth. And since the Fed has managed the real rate to an average of -0.6% since 2000, it implies policymakers have roughly 80 basis points of room to maneuver.

Now let's apply the Cleveland Fed's 3.7% CPI estimate for October. With the target range unchanged at 3.75% to 4%, the real rate holds at about 0.2%. Unless inflation reaccelerates, another hike isn't pressing.

Bottom line: a flat-to-lower October CPI weakens the case for a December hike and lets the Fed stay on hold. The risk is another fuel spike if Middle East tensions flare. Beyond that, lower borrowing costs next year can come from this spring's inflation spike dropping out of the year-over-year math. A Middle East resolution speeding that up. That should help underpin a steady, long-term rally in the S&P 500.

Five Stories Moving the Market:

President Donald Trump said further strikes on Iran wouldn’t be necessary but the U.S. remains “locked and loaded,” an indication that he’s winding down the conflict; the comment came after Trump met with Qatari Prime Minister Mohammed bin Abdulrahman Al Thani, whose nation has served as a mediator between Washington and Tehran – Bloomberg. (Why you should care – an end to the conflict would improve the outlook for global oil supplies, pulling energy prices and inflation lower, while easing investor worries about higher interest rates)

Beijing wants any three-way summit among the leaders of the U.S., China, and Russia to be a highly scripted affair, with each reading a prepared statement and little room for discussion; the Trump administration is pushing for a looser format that would allow more exchange among the three leaders – WSJ. (Why you should care – genuine back-and-forth among the three leaders would signal they’re serious about shared goals, which could ease the geopolitical risk weighing on the stock market)

The U.S. central bank should move its monetary policy "with care" as it maps ‌a response to inflation, according to Federal Reserve Bank of Richmond President Tom Barkin; he also stated had no base case for what should be done at the coming December meeting – Reuters. (Why you should care – Barkin’s comments suggest the bond market may be pricing in a more aggressive rate-hike path than policymakers have in mind)

Canada is widening relief from its retaliatory tariffs on U.S. goods, extending the program to June 2028, and expanding it beyond steel to goods used in manufacturing, farming, mining, and oil and gas; Ottawa will drop relief on some products it can source at home, including certain aluminum wire and extrusions starting February 1, 2027 - Bloomberg. (Why you should care - Canada easing its retaliation keeps the door open to a U.S.-Canada trade deal, and any step back from tariffs helps cool the outlook for inflation growth)

President Donald Trump said there’s a “very strong inclination” toward ending Russia’s war in Ukraine and that both sides are tired of fighting; U.S. officials said Russia and Ukraine are privately showing some flexibility on a possible exchange of territory ahead of talks in Abu Dhabi this week – Reuters. (Why you should care – a peace deal that lifts sanctions on Russia would bring more energy and metals supply back to global markets, likely pulling commodity prices and inflation pressures lower)

Economic Calendar:

Earnings: TDG

BoE's Breeden (Deputy Governor) Speaks (3:30 a.m.)

Fed's Waller (Board, Voter) Speaks (4 a.m.)

Eurozone - Eurogroup Meetings (5 a.m.)

U.S. - NFIB Small Business Optimism Index for October (6 a.m.)

U.S. - ADP Weekly Employment Change (8:15 a.m.)

U.S. - CPI for October (8:30 a.m.)

U.S. - Core CPI for October (8:30 a.m.)

Fed's Logan (Dallas, Voter) Speaks (9:35 a.m.)

China - Trade Balance for October (10:16 a.m.)

U.S. - WASDE Report (11 a.m.)

U.S. - NY Fed Household Debt and Credit Report for Q3 (11 a.m.)

ECB's Lane (Chief Economist) Speaks (11:45 a.m.)

U.S. - EIA Short-Term Energy Outlook (12 p.m.)

Treasury Auctions $42 Billion in 10-Year Notes (1 p.m.)

BoE's Pill (Chief Economist) Speaks (1:30 p.m.)

Fed's Schmid (Kansas City, Non-Voter) Speaks (1:30 p.m.)

BoC Summary of Deliberations (1:30 p.m.)

RBNZ - Financial Stability Report (3 p.m.)

Fed's Bowman (Board, Vice Chair for Supervision) Speaks (3:30 p.m.)

U.S. - American Petroleum Institute Crude Oil Inventory Data (4:30 p.m.)

Fed's Bowman (Board, Vice Chair for Supervision) Speaks (6:30 p.m.)

RBNZ - Financial Stability Report Press Conference (7 p.m.)

Australia - Home Loans for Q3 (7:30 p.m.)