2023-03-14 10:45:25 ET
Summary
- We summarize key data and provide in-depth analysis of the monthly Consumer Price Index report released by the U.S. Bureau of Labor Statistics.
- All items decelerated significantly while Core CPI inflation experienced a slight acceleration.
- Core Services ex Housing, the indicator most closely watched by the Fed, accelerated significantly.
- This CPI report is not supportive of a pause in the Fed's rate hike cycle.
- In addressing recent turmoil in the financial sector, the Fed cannot take its eye off of inflation, which shows signs of stalling at an unacceptably high level.
Summary Data and Analysis
Figure 1 below highlights key summary data and analysis for this month’s All Items CPI.
Figure 1: All Items: Change, Acceleration, Expectations and Surprise
As can be seen above, All-Items CPI decelerated on a MoM basis and was slightly softer than expected. On a YoY basis, All Items CPI decelerated more significantly, however came in slightly above expectations.
Figure 2 below highlights key summary data and analysis for this month’s Core CPI.
Figure 2: Core: Change, Acceleration, Expectations & Surprise
As can be seen above, Core CPI accelerated slightly from the prior month and was slightly higher than expectations. On a YoY basis, Core CPI decelerated but was slightly above expectations.
Analysis of Contributions of Key Aggregate Components of CPI
In Figure 3, we display the contributions to CPI inflation of five major aggregate components to the MoM (month-over-month) change in CPI and the MoM acceleration of CPI.
Figure 3: Analysis of Key Aggregate Components of CPI
We will briefly review how to interpret the table above (as well as other tables in this report), describing each column from left to right. The first column contains the MoM percent change for the current month. The second column contains the MoM percent change in the prior month. The third column contains the MoM acceleration – i.e., the difference between the percent change this month minus the percent change last month. The fourth column contains the Cumulative Contribution to the percent MoM change of CPI. This describes exactly how much each component contributed to the cumulative All Items MoM percent change in CPI. The sum of the values in this column will yield the MoM percent change of All Items CPI (with minor discrepancy due to rounding). Finally, the rightmost column contains the Cumulative Contribution to MoM Acceleration of All Items CPI. The sum of the contributions in this column adds up to the MoM Acceleration of All Items CPI.
Although all five columns provide important information, we recommend that readers pay special attention to the rightmost column (Cumulative Contribution to Acceleration), as it reveals exactly what drove the MoM acceleration/deceleration in CPI during the current month compared to the prior month.
As can be seen in the table above, Energy decelerated significantly, accounting for most of the overall deceleration in All Items CPI. However, the most important thing to note in this table is that Core Services except Housing -- the indicator the Fed is currently paying most attention to -- accelerated significantly.
More granular details will be provided below.
Analysis of CPI Components that Contributed Most to Change and Acceleration of CPI
In the following section, we perform the same contribution analysis as above, but at a more granular level of detail. In Figure 4 below, we list the top 10 CPI components (most granular level) that contributed negatively and positively to the MoM percent change in All Items CPI. These contributions take into account both the magnitude of the MoM change in each component as well as the weight of each component in All Items CPI.
Figure 4: Top Contributors to MoM Percent Change
Housing continues to dominate the positive contributions to CPI. However, housing inflation has peaked. It should be noted that real-time indicators of housing inflation are indicating strong deflationary trends in apartment rents, which will become reflected in CPI data within a few months.
Some volatile components, such as used car prices, continued to weigh down the CPI. However, based on real-time indicators, the disinflationary effects of some of these categories will probably subside or even be reversed.
In Figure 5 below, we list the top 10 CPI components, at the most granular level, that contributed negatively and positively to the MoM acceleration (expressed in percent change) of All Items CPI. These contributions take into account both the magnitude of the MoM accelerations in the components as well as the weight of each component All Items CPI.
Figure 5: Top Contributors to MoM Acceleration
It's worthwhile to examine tables 4 and 5 above carefully as they're likely to include most or all of the items which surprised forecasters during the month.
The most significant change from last month to this month was the strong deceleration of Utilities. The sharp increase and acceleration of airline fares was also notable.
Top Movers
In Figure 6 below, for general interest purposes, we show the components with the largest positive and negative MoM change (%). The YoY change in these particular components is to the right.
Figure 6: Top Movers MoM Percent Change
Eggs are no longer the leading inflationary item and in fact fell significantly this month (-6.65%). In February, women's dresses and airline fares experienced the largest inflationary pressures.
Implications for The Economy & Financial Markets
In this section, we review the potential implications of this month’s CPI report on policy (monetary and or fiscal) and on the overall outlook for the U.S. economy. We also analyze potential implications for financial markets.
Economic implications. The Fed should not be particularly comforted by this report. Core services ex-housing -- the indicator that the Fed currently considers to be the most important -- actually accelerated significantly during February.
Recent instability in the US financial system and distress in interbank markets may dissuade the Fed from hiking interest rates at the next meeting. However, there is nothing in this report that should give the Fed any cause for complacency about the trajectory of inflation. Overall inflation appears to be getting "stuck" at level which is far higher than the Fed's 2.0% target. If inflation fails to fall quickly toward that target, the Fed's credibility will be damaged and long-term inflation expectations could rise. The implications of this were discussed my article yesterday. In the long-run, such a state of affairs could place pressure on the U.S. Dollar and U.S. dollar denominated assets (e.g., U.S. Treasury Notes) in international markets. Furthermore, rising long-term inflation expectations would tend lower the market value of all long duration assets including long-term bonds and stocks.
Market implications. The market has rallied strongly in the face of today's CPI numbers, which, at least on the surface, were in line with expectations. The market is essentially evincing "relief" that the numbers did not come in significantly greater than expected, which would have been potentially disastrous.
Much of the rally in equity markets is probably more related to subsiding pessimism about the banking sector than it is to relief about the CPI.
Regarding CPI, today's numbers are actually somewhat concerning when you look under the surface, particularly at core services ex housing.
I expect the panic surrounding the U.S. banking sector to subside soon. If I am correct, the market will be back to focusing on inflation and the Fed's reaction to stubbornly high inflation.
Bond markets have recently greatly downgraded their expectations for Fed Funds rate increases during the remainder of 2023. I believe, markets could experience whiplash, as I believe that it is likely that within a few weeks the banking sector "scare" will have been addressed by authorities and largely forgotten by the public.
It is my view that within a few weeks the market will be back to fretting about inflation and the Fed's terminal rate.
Today's CPI report certainly does not provide any support for the Fed pausing rate hikes. Although it would not be surprising to me if the Fed paused for one meeting, the Fed will have to continue hiking rates at future meetings this year if CPI in future months follows the patterns that we have seen February and January, which is of a disinflationary process which has stalled and inflation getting "stuck" at an unacceptably high level.
For further details see:
CPI: Market Is Relieved But Fed Is Not