US Inflation Hits 3.6% as Iran War Fuel Shock Outpaces Incomes

A hot inflation print lands days before the midterms

The Federal Reserve's preferred inflation measure picked up again in September. The war with Iran kept pushing up fuel costs, and household incomes did not keep pace. The Personal Consumption Expenditures (PCE) price index rose 3.6% from a year earlier, up from 3.4% in August and the highest annual rate since May.31 Prices rose 0.5% from August to September, the biggest monthly gain since March.31 The core index, which leaves out food and energy, rose to 3.1% from 3.0%.32

The headline number was a little below the 3.7% economists had forecast, which is the only good news in the release.31 Gasoline and other energy goods jumped 9.2% in a single month.31 September was the 67th straight month of inflation above the Fed's 2% target.31

The timing makes it political. The report came out less than a week before midterm elections in which affordability has become a central issue.32 It was also the last full picture of the economy before voters go to the polls. Read together with the jobs, consumer price, spending and growth data released over the past month, it shows strong overall output, rising prices, and households paying for it by saving less.

The war is clearly behind the energy spike

All the major coverage agrees on the main cause. The consumer price index (CPI), released two weeks earlier, rose 3.7% from a year earlier, up from 3.4% in August.34 The monthly gain of 0.6% matched forecasts, but the annual rate beat the 3.6% consensus.20 Gasoline rose 9.1% in the month and accounted for more than half of the CPI's increase. Gas is up about 34% from a year ago, and fuel oil is up 74.2%.12 Energy prices overall rose 5.2% in September and 20.4% over the year.13

The chain of events is well documented. The war began in late February with U.S. and Israeli strikes on Iran. It cut oil flows through the Strait of Hormuz and damaged refining capacity across the region.34 U.S. crude is still above $100 a barrel, compared with less than $70 before the war.32 Diesel matters most for how far the shock spreads, because it powers freight, farms and shipping. Its price has risen roughly 68% since just before the war, to about $6.30 a gallon.34 Moody's Mark Zandi said the war's "fingerprints" were all over the CPI report.34

The higher costs are now reaching services that use fuel. Airfares are up about 22% over the past year.19 RBC's Michael Reid called the current inflation an "oil story" that will last for a few more months.34 An analysis by the Wells Fargo Investment Institute warned that lost refining capacity and distribution problems could keep energy prices high until mid-2027, even after shipping lanes fully reopen.34

Is inflation spreading beyond fuel?

This is where the coverage disagrees. Pierre Yared, a former member of Trump's Council of Economic Advisers, has argued that core CPI is only "mildly higher" than its long-run average.15 Core CPI rose to 2.6% from 2.4% in September.12 That supports the view that the energy shock is still mostly contained.

Other data point the other way. Core CPI rose at a 3.7% annualized pace in September, which led Carson Group's Sonu Varghese to say investors keep being surprised by broad-based inflation.12 So-called supercore inflation, which covers services excluding housing, rose 0.4% for the second month in a row and has run at an annual rate of nearly 4.6% over three months.13 Fifth Third's Bill Adams called the CPI report worse than expected, with increases across durable goods, nondurable goods and services.19 Navy Federal's Heather Long said there is legitimate concern that inflation is spreading beyond energy. She pointed to tariff-driven goods inflation, a pickup in services, and rents that have stopped improving.33

There are other pressures besides the war. Tariffs and transportation costs pushed prices for toys and other recreational goods to their largest monthly increases on record.11 Goldman Sachs estimates that the AI buildout has added about half a percentage point to annual PCE inflation.19 Groceries were a rare bright spot, slipping 0.1% in September.19

Our reading: the optimists are looking at the wrong number. The core year-over-year rate is flattered by earlier months. The monthly and three-month trends are what show momentum, and they are heading the wrong way. Core PCE has stayed at or above 3.0% since the war began.

Households keep spending by saving less

The spending data contain the most worrying detail. Nominal consumer spending rose 0.5% in September, but after adjusting for inflation it was flat.35 Personal income rose just 0.2%. Real after-tax income fell 0.3%, its first drop since May.31 To keep up, households cut their saving, and the saving rate fell to 3.8%.31 Outlets describe that as the lowest since late 2022, though they disagree on the exact month.31

This continues a pattern from August. That month, real spending jumped 0.6% and the saving rate fell to 4.1%. Nationwide's Kathy Bostjancic said squeezed households were either saving less or borrowing more.38 PNC's Gus Faucher warned that spending growing faster than income cannot last. He noted that much of the spending has come from high-income households supported by the stock market.38 One analysis summed up September this way: households paid more and got almost nothing extra for it.5

Consumers are unhappy about it. The University of Michigan sentiment index fell to 48 in October, close to May's record low of 44.8.33

Strong growth hides some weak spots

Growth looked strong on paper. Real GDP grew at a 3.4% annualized rate in the third quarter, up from 2.2% in the second.1 That beat the 3.2% consensus and the Atlanta Fed's 3.3% GDPNow estimate.6 Consumer spending grew at 3.8% and business investment, excluding housing, at 12.7%.3 Spending by private households and businesses rose 4.9%.1

A closer look gives a less impressive picture. Inventory building added 1.61 percentage points to growth, while trade subtracted 3.32 points.5 A broader measure of final sales grew only 1.7%.2 Government spending got an accounting boost from smaller sales out of the Strategic Petroleum Reserve. The BEA says those sales have no direct effect on overall GDP.6 EY noted that growth is concentrated in a few sectors and that cracks are becoming more visible among consumers.2

The GDP report also contains a figure that looks odd. Its quarterly PCE price index rose at just a 2.1% annualized rate, down from 5.0%.1 That is a measure of change from quarter to quarter, and it fell after a very sharp second-quarter jump. It is not a sign that inflation has cooled. The monthly data for September clearly show prices speeding up again.31

The jobs market is softening

The September jobs report was weak. Employers added only 29,000 jobs, against forecasts of 84,000. Unemployment rose to 4.2%, and revisions cut 60,000 jobs from July and August combined.21 Hourly earnings were up 3.0% from a year earlier.22 With CPI at 3.7%, that means real pay is falling.

Again, interpretations differ. Unemployment rose by only 0.03 percentage points and was not statistically significant.26 It also rose partly because 485,000 people joined the labor force.21 Some analysts blamed a calendar quirk for the payroll miss. They also noted that retirements and immigration enforcement are shrinking labor supply, which lowers the number of jobs needed to keep unemployment steady.28 Others pointed out that unemployment among Black workers jumped to 7.0% from 6.0%.27 Unemployment has stayed between 4.1% and 4.3% since March.23 That looks like cooling, not collapse.

The Fed is caught between rising prices and weaker jobs

The Fed raised rates in September, its first hike in three years.38 It then held at 3.75%–4% on October 28.35 Chair Kevin Warsh acknowledged that energy prices had risen again in recent weeks.35 Markets put the odds of a December hike at about 84.6%.35 Wells Fargo expects more tightening through spring 2027.34 Higher rates are already reaching households. The 10-year Treasury yield rose to 5.3% after the CPI report.16

Our view: the Fed is likely to hike again. Strong GDP gives it cover, and core inflation trends give it reason. Inflation is near three-year highs, real incomes are falling and savings are thin. The risk is that the Fed tightens just as the consumer spending that has carried the economy starts to give out. Faucher warned that spending cannot keep growing faster than incomes for long.38