Fedwatching: Some thoughts on yesterday's CPI report

Yesterday's CPI report came in higher than expected at 3.1% annualized through January, prompting a selloff in stocks and bonds. Stocks were down ~1.5% and bond interest rates climbed ~0.10-20%, concentrated in the 3-5 year range.

Overall, I interpret this report as a warning sign for the Fed. The last mile of taking inflation down from 3% to 2% is not going to be easy. I don't think anyone on the FOMC feels good seeing this print.

  • With inflation being higher, this reduces the amount of rate cutting the Fed is likely to do this year. Market pricing now suggests 2 rate cuts this year, in the summer or later, rather than 3.
  • Based on recent Fed speeches, I think the odds of a March cut were already extremely low. Surprised to see media outlets still talking about it.
  • Housing costs, which comprise about 36% of the index, increased 0.6% month-over-month, a higher rate than the last two readings. Other services--health care and transportation--also rose sharply. The increase here is especially stark in contrast to goods prices, which went down in the aggregate.
  • The divergence between goods and services prices is early confirmation of the "worry" scenario outlined by several recent Fed speakers, which is that goods price inflation is mostly taken care of due to supply chain pressures easing but it's not clear where services disinflation will come from.
  • Kugler and others hoped that housing services inflation would come down as renters roll into new leases, but that didn't show up in January's data at least. Anecdotally, I hear a lot about rental rates coming down nationwide but again it's not appearing in this data report, at least.
  • Although other services inflation is a relatively small part of the CPI, the sharp price increases can't look good to people like Williams who have wondered where the last mile of services disinflation would come from. Several FOMC speakers have remarked on the labor market "coming into better balance" as alleviating price pressures in services, but last month's gangbusters jobs report casts doubt on that narrative as well.

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