February CPI: Not Bad, Not Good

Headline and core inflation for February printed at 3.2 and 3.8 percent, respectively, 0.1 percentage points above consensus estimates. Energy added to inflation for the first time since September as wholesale energy prices recovered, while food prices stagnated. Moving through core inflation, goods prices increased by 0.1 percent month-over-month (m-o-m) as apparel, used cars, and staple goods increased. Goods prices have stagnated for 18 months as supply chain improvements met falling demand for goods. Both factors are fading, but we think goods prices will continue to be a negligible contributor to inflation unless trade frictions increase, a risk given trade’s prominence in the election debate.

Ahead of the print, focus on the services sector was even more pronounced after CPI for January saw worrying developments in both shelter costs and core services. Starting with shelter, owners’ equivalent rent (OER) i.e., the cost of owning a home, diverged materially from rent of primary residence. This was strange as the two series are derived from the same source data with differences accounted for by weighting across housing types. The BLS stoked further confusion with an email suggesting that weights were the primary reason for the divergence before retracting the email. With OER having the single-largest weight in the index, uncertainty was elevated. However, the gap between the two narrowed in February with OER and tenant’s rent coming in near 0.4 percent m-o-m.

The uncertainty for shelter was as much a story about data construction as it was the underlying trend, whereas core services inflation uncertainty centered on whether the underlying trend is settling at a level inconsistent with 2 percent inflation. Core services halved from 0.85 percent in January to 0.47 percent in February. With hindsight, the elevated January print likely reflected seasonal effects in the services sector given wages reset in many industries at the turn of the year and the several of these sectors are not seasonally adjusted within CPI. However, the underlying trend remains elevated as February demonstrated. Looking at the Atlanta Federal Reserve’s (Fed) sticky core CPI measure excluding shelter, the 3-month annualized rate increased to 4.6 percent.

Source: Bloomberg, March 2024

Note: Areas in chart may not add up as price declines are truncated.

At their meeting next week, the FOMC will likely judge that there has been little progress on inflation in 2024. Alongside growth surprising to the upside year to date, we expect positive revisions to the Committee’s forecast for growth and inflation. The shift in market pricing from 6 cuts at the start of the year to 3 cuts reflects these revisions as well. If we look at market pricing for 3 cuts and assume the distribution around that includes some weight on a recession, we think the most likely path for Fed cuts in the market is 1 or 2 cuts at this point. We expect the Fed’s median 2024 dot to show one fewer cut at 2 cuts as well with the risk to a larger shift up in the Fed’s median rate path. Moreover, the Committee will provide more information on the plan for tapering quantitative tightening whether it comes in the form of a statement of their plan or Chair Powell’s press conference. Going into the meeting the balance of risks are skewed to the hawkish side given the inflation data coming against a backdrop of easing financial conditions.

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