Key Highlights

● Headline PCE Inflation accelerated in September, driven mainly by energy and gasoline prices.

● WTI settled at $102.00 and Brent at $114.88 on Thursday.

● Core inflation also edged up, but by less than the headline measure.

● Fed Governor Lisa Cook and Beth Hammack dissented in favor of a hike.

The Fed's preferred inflation gauge heated up in September, and the main culprit was not hard to find: a war-driven spike in energy and gasoline prices.

The reading

The personal consumption expenditures price index, the inflation measure the Federal Reserve watches most closely, accelerated in September. The headline year-over-year rate rose from August's pace, and prices also climbed briskly on a month-over-month basis, according to market data. The data was released at 8:30am ET on Thursday, October 29.

Reports differed on how the figure compared with forecasts. One source said all of the readings matched estimates, while another said the headline number came in slightly below consensus. Either way, the direction was unwelcome for a Central Bank trying to bring inflation down.

Energy did the heavy lifting

The biggest driver was energy. Energy prices jumped in September and gasoline costs surged even more steeply, according to one report, which tied the increase to a war-related oil squeeze.

Oil markets have been under intense pressure from conflict involving Iran. Brent Crude recently touched a four-year high, and WTI has held above $100 a barrel since the week of October 23, according to market commentary. On Thursday, WTI settled at $102.00 and Brent at $114.88, according to media reports.

When crude rises, gasoline prices follow quickly, and gasoline carries significant weight in household budgets. That makes headline PCE especially sensitive to swings at the pump.

Headline versus core

Economists often strip out food and energy to calculate core PCE, which is considered a better guide to underlying inflation trends. Core Inflation also edged up in September, according to market data, but by less than the headline measure.

That gap tells an important story. Most of the acceleration came from energy, a volatile category that can reverse quickly if oil prices fall. But core inflation moving higher too suggests price pressures are not confined to the gas station.

The Fed's reaction function

Chair Kevin Warsh has taken a firm line on inflation. "It's our responsibility to get inflation down," he said on Wednesday, according to media reports. He added that "there's no soft inflation target and no implicit inflation target."

Some central bankers prefer to "look through" energy shocks, arguing that Monetary Policy cannot control oil prices. But a prolonged energy shock can feed into expectations and wages, which the Fed can influence. That is one reason the hawks are watching closely.

Governor Lisa Cook and Cleveland Fed President Beth Hammack dissented in favor of a hike at Wednesday's meeting, according to media reports. "Today's data strengthens the case for another rate increase in December," said one Wealth advisor, according to market commentary.

Markets absorbed it

Because the numbers were close to expectations, markets did not panic. The 10-year Treasury Yield actually eased. Gold fell, down $42.00 to about $4,024.60, as hot inflation supported Fed tightening bets.

Stocks were mixed: the S&P 500 slipped 23.59 points to 7,720.39 and the Nasdaq Composite dropped 365.13 points to 26,184.72 on Alphabet (NASDAQ:GOOGL)'s historic slide, while the Russell 2000 rose 28.71 points to 2,859.22.

What to watch

Oil is the swing Factor for headline inflation. Diplomatic efforts with Iran could ease prices, while new attacks on energy infrastructure could push them higher. One Commodity analyst said Thursday that "Oil prices are under pressure today amid renewed diplomatic efforts to de-escalate the conflict in the Middle East."

Friday's third-quarter Employment Cost index will show whether inflation is spreading into wages. The Fed's next decision arrives December 8–9, and every inflation reading between now and then will be scrutinized for signs that energy costs are spilling into everything else.