CPI Inflation Climbs to 3.7%, Putting October Fed Hike in Play

From 3.4% to 3.7%: the inflation rate moves the wrong way

August's 3.4% annual inflation rate is no longer the headline number. The Bureau of Labor Statistics' September consumer price index showed prices rising 0.6% on a seasonally adjusted basis, faster than August's 0.4%, and lifted the 12-month rate to 3.7%.11 Headline inflation had held at 3.4% in both July and August, so September ended two months of stability.4 Economists surveyed by Dow Jones had forecast 3.6% annually and 0.6% for the month. The monthly figure matched expectations and the annual rate beat them.1

The headline beat was small. The bigger problem for the Federal Reserve sits underneath it. Core CPI, which leaves out food and energy, rose 0.3% for the month and 2.6% over the year, above the expected 0.2% and 2.5%.1 Calculated over three months, core inflation ran at a 3.4% annualized pace, up from 2% in August.3 This was also the last CPI report before the midterm elections and the last inflation reading policymakers will see before their October 27–28 meeting.265

Energy drove the headline, but not alone

Energy is the clearest cause. Gasoline prices jumped 9.1% in September and accounted for more than half of the monthly rise. The energy index gained 5.2% for the month and is up 20.4% from a year earlier.11 Gasoline is 34.2% more expensive than a year ago, and fuel oil is up 74.2%.11 Coverage consistently links the energy spike to the war with Iran, which began in late February and has limited global oil supply.15 CPI had been drifting lower early in 2026 before the U.S. and Israeli strikes on Iran pushed it back up.1

The energy shock is not the whole story, and this is where reporters and analysts most clearly agree. Shelter rose 0.4%, up from 0.3%. Recreation, used cars and trucks, education, airline fares, medical care and apparel all increased.11 Airline fares are up 22.4% from a year ago, partly because of higher jet fuel costs.615 Apparel prices, which respond to tariffs, are up 3.4% over the year.1 Glenmede's Jason Pride called it the first report of the year in which price pressure seemed to show up across most of the consumption basket at the same time. A Fitch Ratings economist warned that higher energy costs are starting to spread into services prices.3 Carson Group's Sonu Varghese said September's core increase works out to a 3.7% annualized pace.1

A few categories pulled the other way. Food was flat for the month, and grocery prices fell 0.1%.11 Communication declined.11 Medical care commodities fell for a seventh straight month.17 Those offsets mainly show how narrow the relief now is.

Treasury yields: a spike, then a reversal

The bond market moved immediately. The two-year Treasury yield, which tracks Fed expectations closely, rose about 12 to 13 basis points. One account had it at 4.93%, and another reported a rise of about 0.1 percentage point to 4.88%.32722 The 10-year yield climbed roughly 8 to 10 basis points to about 5.3%, near levels last seen in early 2002.2621 At one point in the session it reached 5.33%.23 The 30-year yield rose to about 5.61%. Before the report, the 10-year and 30-year had already touched 24-year highs of 5.365% and 5.733% before retreating after well-received auctions.30 Stock futures turned lower and the S&P 500 opened down 0.4%.122

That move reversed within a day. On Thursday the 10-year yield dropped to about 5.08%–5.11%, a three-week low. A deepening selloff in technology and AI stocks pushed investors toward government bonds.2123 The two-year fell back to about 4.75%.21 Yields fell even after more inflation news: producer prices jumped 1.3% in September, the largest monthly rise since March 2022, and are up 6.3% from a year earlier.2129

In our reading, this split matters more than the CPI beat itself. Short-term yields are reacting to a Fed that looks set to keep tightening. Long-term yields now also reflect concern about growth and risk appetite, especially as AI-related stocks fall. Fed Governor Christopher Waller has argued that higher Treasury yields are already slowing the economy, which could make another hike less urgent.10 Thursday's market moves support that view somewhat. September's core data weakens it.

Consumer spending: strong totals, softer detail

Spending data released the same week is mixed. Retail sales rose 0.8% in September, well above the 0.3% forecast.21 Excluding autos and gasoline, sales rose only 0.2%. The control group, which feeds into GDP estimates, gained 0.1%, short of the expected 0.3%.29 Retail sales are not adjusted for inflation, so much of the headline gain probably reflects higher gasoline prices rather than more goods bought.29

This fits a concern economists keep raising. EY-Parthenon's Gregory Daco calls it an "income erosion phenomenon" and expects inflation to stay high through year-end, cutting into what households can spend.26 Navy Federal's Heather Long said many Americans are worse off than they were six months or a year ago.8 Consumer inflation expectations for the next year rose to 3.9% in September from 3.6%. Five-year expectations held at 3.0%.4 That short-term jump is the kind of slippage the Fed worries could become entrenched.

Social Security recipients will get a 3.6% cost-of-living increase for 2027, calculated from the July–September CPI-W data.15

The GDP angle: growth that gives the Fed room

The growth backdrop explains why the Fed can talk about hiking at all. Second-quarter real GDP was revised up to a 2.2% annualized rate from 1.5%, beating forecasts. First-quarter growth was revised to 2.5%.31 Real final sales to private domestic purchasers rose 4.6%.31 EY estimated real consumer spending growth at 3.8% annualized and business investment at 9.0%, helped by AI-related spending on equipment and intellectual property.34 Investment in data centers was a leading contributor to nonresidential structures.32

EY expects third-quarter growth above 4% annualized and full-year 2026 growth near 2.5%. It also expects most of the gains to go to corporate profit margins, which reached a record 14.5% of GDP, while households lose ground.34 The second-quarter PCE price index rose at a 5.0% annual rate. Not every indicator looks strong: September payrolls rose by only 29,000.9 The advance estimate of third-quarter GDP is due October 29, the day after the Fed's decision.33

Cleveland Fed's Beth Hammack has argued that demand-side pressure from the AI buildout will not correct itself, even if energy prices fall when the war ends.8 Chicago Fed's Austan Goolsbee called the CPI figures "discouraging" and also raised the possibility that AI infrastructure spending is overheating the economy.21 In this view, strong growth is part of what is pushing inflation up.

What the Fed does on October 28

The Fed raised rates by a quarter point in September, its first increase in more than three years, to a target range of 3.75%–4%.1 Before the CPI report, markets expected the Fed to wait until December for the next hike.6 After it, estimates of the odds of an October hike ranged widely. CNBC cited about 54%. Axios reported 47%, up from 22.1% the day before. Yahoo Finance reported 35%, and Polymarket briefly neared 50% before falling back toward 30%.135 By Thursday, traders again expected a hold in October and a December hike.21 Long called October a "coin flip" but expects the Fed to hold before the midterms.8

We expect a hold in October with explicitly hawkish guidance. New York Fed President John Williams has signaled one more hike this year.10 Holding a policy change a week before a national election is a strong institutional habit. The Fed's preferred PCE data for September won't arrive until after the meeting.30 Cleveland Fed estimates put September PCE inflation at about 3.6% and core PCE at about 3.05%.24 Those figures are well above target and consistent with further tightening. The Fed did raise rates just before the 2022 midterms, so that habit is not a fixed rule.8

Realtor.com's Jake Krimmel summed up the outlook: the question is now when the Fed hikes again, not whether.5 Markets are pricing at least two more increases in 2027.1 With core inflation speeding up and growth holding firm, those expectations look reasonable.