The September inflation report released on Thursday will prompt the Federal Reserve to continue its process of normalizing interest rates. With a healthy labor market and price growth close to target, Federal Reserve officials are determined to return to a monetary policy stance that neither stimulates nor drags down the U.S. economy, and they believe there is ample time to achieve this goal.

Currently, the market widely expects the Federal Reserve to adopt small rate cuts in the next few meetings, with each cut of 25 basis points still being the main expectation of investors.

Recent data, while not fully proving that the U.S. economy will achieve a "soft landing," show that the possibility is increasing. Jobs are still being added monthly, and although the unemployment rate has risen compared to last year, the average unemployment rate has remained at a relatively low level of 4.2% over the past three months. The real gross domestic product is expected to grow at an annualized rate of around 3% in the third quarter.

The September Consumer Price Index (CPI) released by the U.S. Bureau of Labor Statistics on Thursday morning showed that price increases exceeded expectations. Core prices, excluding food and energy, rose by 0.3% for the second consecutive month, up 3.3% year-on-year. The monthly increase of about 0.17% is in line with the Federal Reserve's annual inflation target of 2%.

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However, policymakers will not panic as a result. The Federal Reserve's preferred inflation measure—the Personal Consumption Expenditure Price Index (PCE)—has different weights in different price categories, especially its lower weight on housing costs, which has kept this year's PCE performance below the CPI.

The PCE price index data for September will be released on October 31, exactly one week before the Federal Reserve's November interest rate decision. According to the consensus forecast of economists surveyed by FactSet, the core PCE index rose by 0.2% month-on-month in September and by 2.5% year-on-year.

Although this figure is still above the target, it has dropped significantly from the nearly 4% level last year. Even if the Federal Reserve gradually lowers interest rates, they will remain in a "restrictive" range in the next few quarters, exerting further downward pressure on inflation until it approaches the 2% target.

New York Fed Chairman Williams said on Thursday: "We have adopted and maintained a very tight monetary policy stance until the data gives us confidence that inflation is steadily heading towards the 2% target." He added: "As we make progress in achieving price stability, gradually shifting to a more neutral monetary policy stance will help maintain the strength of the economy and the labor market."

The "neutral interest rate" refers to a theoretical level that neither stimulates nor inhibits economic activity. According to the minutes of the Federal Reserve's policy meeting on September 17-18, released on Wednesday, officials discussed using the neutral interest rate as a target for medium- and long-term rate cuts. At that meeting, the Federal Reserve lowered the target range for the federal funds rate by 0.5 percentage points, to a range of 4.75% to 5.0%, after keeping rates unchanged since July 2023.

Many economists believe that the neutral federal funds rate for the U.S. economy should be between 2% and 3%, while Federal Reserve officials showed in their September economic forecast update that they expect to cut rates by 100 basis points this year and another 100 basis points by the end of 2025, thereby lowering the target range to 3.25% to 3.5%.Policymakers' median long-term federal funds rate forecast is 2.9%.

Unless inflation shows a significant acceleration, merely the moderate data results announced on Thursday are not enough to prompt the Federal Reserve to pause rate cuts, especially when rates are still far above what they consider to be the neutral level.

Moreover, policymakers are also paying attention to the side of their dual mandate that maximizes employment and have indicated that these goals are essentially balanced at present. Recent data does not call for faster rate cuts to save the labor market, although that market seems to be cooling. This implies that the substantial rate cut in September may be a one-off event unless there is a faster deterioration.

Data on unemployment insurance claims for the week ending October 5 was also released on Thursday. The number of initial claims for unemployment benefits surged to the highest point in 14 months, reaching 258,000, up from 225,000 the previous week, and the number of continuing claims for unemployment benefits also rose. This is not an encouraging signal for the labor market, but these increases are likely related to Hurricane Ian affecting large parts of the southeastern United States.

Several Federal Reserve officials have stated that they wish to keep the U.S. economy in its current state and believe that an orderly rate-cutting process is the way to achieve this goal. This suggests that moderate rate cuts may continue in the coming months.