United States
After three soft inflation prints in a row, the CPI report provided a reminder that the path to the Fed’s 2% target is some way away yet.
Headline and core CPI both came in line with expectations at 0.5% and 0.4% month-on-month, respectively, (from 0.1% and 0.4%) or 6.4% and 5.6% year-on-year.
There were relatively few negative contributors across the index on a month-on-month basis, with the most notable exceptions included in Table 1 below. Services inflation once again led the way, followed by energy (which rebounded), while goods disinflation slowed.
Table 1: Shelter prices and energy inflation lead the way
| Sticky | Flexible | Non-Core | |||||
|---|---|---|---|---|---|---|---|
| Health services | Owners' Equivalent Rent | Airfare | Used Cars | Apparel | Food | Energy | |
| 12-month Average | 0.2% | 0.6% | 2.1% | -1.0% | 0.2% | 0.8% | 0.8% |
| Aug-22 | 0.7% | 0.7% | -1.5% | -0.2% | 0.3% | 0.8% | -3.9% |
| Sep-22 | 0.8% | 0.8% | 0.4% | -1.1% | 0.0% | 0.8% | -1.7% |
| Oct-22 | -0.4% | 0.6% | -1.2% | -1.7% | -0.2% | 0.7% | 1.7% |
| Nov-22 | -0.5% | 0.7% | -1.6% | -2.0% | 0.1% | 0.6% | -1.4% |
| Dec-22 | 0.3% | 0.8% | -2.1% | -2.0% | 0.2% | 0.4% | 2.0% |
| Jan-23 | -0.7% | 0.7% | -2.1% | -1.9% | 0.8% | 0.5% | 2.0% |
Source: Bureau of Labor Statistics, Bloomberg, February 2023
Core CPI is proving somewhat persistent despite favorable base effects
As we highlighted previously, inflation still looks likely to fall over the first half of 2023, mainly due to favorable base effects, but this tailwind will potentially run out in June.
If we project the 6-month monthly average forward to illustrate base effects, we see headline CPI continuing to make significant progress, but core inflation at greater risk of stabilizing by the summer, speaking to the potential persistence of the index’s less volatile components (Figure 1). As such, it may need more than base effects to bring CPI sustainably closer to target.
Figure 1: Core CPI may prove stubborn even as headline CPI rides base effects down
Source: Bureau of Labor Statistics, FRED, Insight calculations, February 2023
Services CPI still going strong
Of these stubborn core CPI components, Fed chair Powell is closely watching services CPI, particularly core services excluding shelter. The measure (shown by the light blue bars in Figure 2), accelerated this month, offering little comfort to the Fed.
Figure 2: Services inflation continues to be the Fed’s greatest challenge
Source: Bureau of Labor Statistics, FRED, Insight calculations, February 2023
Nonetheless, the descent in shelter inflation will potentially be painfully slow. The Bureau of Labor Statistics (BLS) measures rents through samples that are only refreshed every six months. This means that, as underlying prices change they will filter through into the data gradually. Shelter inflation may crest for some time before slowing later in the year.
Medical services are the other major services category. It is no surprise to us to see it resume a downward trajectory, given a persistent drag from medical insurance which we expect to continue into October.
Energy provides an uplift to inflation
Energy continues to be a highly volatile component of the index. Last month it was the largest negative contributor to headline CPI, while this month it is the second highest after shelter, contributing 0.17%.
Energy prices saw a boost during January. A significant factor was unusually cold weather in California. This appeared to offset relatively warm weather on the East Coast. Daily gasoline prices also rose 8.9% in January, albeit they remain 30% below last year’s peak.
Volatility continues. So far in February, energy prices have started falling again as weather has normalized. Geopolitics will continue to be a driver over the longer term as China reopens and developments in the Russia / Ukraine war continue to impact the market. At the current pace, however, energy is set to retrace its gains next month.
Core goods disinflation could be set to slow down
Disinflation in goods remains a longer-term theme, with core goods prices up only 1.3% year-on-year, the lowest since February 2021. However, month-on-month core goods rose slightly at 0.07%, the fastest since September, mainly on advances in apparel and new cars, indicating this trend could be slowing down.
On the negative side, used cars were once again the largest negative contributor to the index, falling 1.9% and contributing -0.07%. However, this category is potentially set to reverse course next month. Its leading indicator, the Manheim Used Vehicle index, rose 2.5% in January, the fastest since November 2011 (now 12.8% below its 2021 peak). Supply and demand imbalances are still playing out despite recent supply chain improvements, as indicated by the ratio of auto inventories to sales, which is still around all-time lows and has been a solid indicator of pricing (Figure 3).
Figure 3: Used cars were the worst performing category, but are set to reverse next month
Source: Mannheim, BLS, Insight calculations, February 2023
No market surprise despite methodology changes
Inflation was in line with expectations despite the added element of uncertainty. As this was the first CPI print reflecting 2023 data, there were some methodology changes.
The BLS provided its annual refresh of seasonal adjustments for the last 5-years of data. The notable impact was to revise up recent data, indicating disinflation is occurring at a slower pace than previously reported. For example, goods were reported to have fallen, at -0.1% month-on-month last month, but that print was revised up to 0.1% instead.
The BLS also improved the sampling methods for the shelter components of CPI to track a more representative mix of detached and non-detached houses. Secondly, it has discontinued its “new vehicles” CPI series and replaced it with two series separately tracking new cars and new trucks, adding a data source to achieve this.
The BLS also refreshed the index weights, based on updated consumer expenditure data, which it will now do annually instead of biannually. Most notably in our view, the of core services rose from 56.5% to 58.1%, within this, while shelter’s weighting rose from 32.9% to 34.4% weight. Notably, energy’s weighting fell from 8.8% to 6.9%. On the margin, this could help headline and core CPI fall faster over the year if the shelter component begins to fall (as we expect it will).
No victory yet on inflation
CPI is continuing to moderate, but it will be an uneven path towards the Fed’s target of a sustainable ~2% regime. We expect more progress on headline CPI until the summer, but progress in the stubborn Core CPI services categories (particularly non-shelter and non-medical) are the ones to watch. Once the Fed sees weakness there, it will be one step closer to declaring victory.
For now, we expect the Fed will continue to adopt a cautious tone, particularly given excellent labor market data released earlier this month. The Fed also faces a communication challenge to keep financial conditions tight enough to reduce inflation in the services categories. As such, we expect the Fed to continue to guide towards more hiking activity.
