Today’s CPI report shows a 0.5% increase in the monthly inflation rate, which is slightly higher than economists were expecting. Going forward, inflation is unlikely to maintain its recent pace of deceleration.
Getting from 6.4% in January to a 2% target rate could take longer than what markets are hoping for. When we put all the data together—January’s over-the-month inflation rate, the strong January jobs report, and Chair Powell’s recent speech—it should not be surprising to see 25bp rate hikes continue in the second half of 2023, after the two 25 bp hikes in March and May that markets have already priced in.
We need to keep our expectations realistic when it comes to the trajectory of the disinflationary process ahead of us. Even though the over-the-year inflation rate slowed down to 6.4% from over 9% in months, it could be a rocky road from here.
The increase in shelter index was by far the largest contributor to the monthly all items increase, accounting for nearly half of the monthly all items increase, with the indexes for food, gasoline, and natural gas also contributing. On the bright side, more timely private data from Zillow shows that home prices decreased sharply in the recent months.
Uncertainty regarding how high the terminal interest rate will get and when it will be reached has caused businesses to pause investments and adjust their hiring plans. Private fixed investment in homebuilding, equipment, software development, and R&D has plummeted in response to higher interest rates, and planned hiring has fallen, too, according to business surveys, although the effects of a pullback in planned hiring have yet to be seen in BLS employment data.
Here are some highlights of today’s report, which is sure to shape the Fed’s decisions in the upcoming months:
- Core inflation: Excluding volatile food and energy, inflation accelerated further in January, increasing 4.4% for the last 3 months, compared to 4.0% last month. This is concerning as the trend in core inflation tends to be predictive of future inflation.
- Super-core inflation: Inflation in core services excluding shelter, decelerated slightly in January, but still remains high, propped up by rising consumer spending on services. Today’s super core inflation tells us that we are yet to see the delayed impact of the rate hikes on the overall prices.
- Real earnings: Real wage growth is one of the most important labor market indicators for the data-dependent Fed. Real earnings decreased 0.2% in January as a result of an 0.3% increase in average hourly earnings combined with 0.5% in the CPI. Negative real wage growth might slow down demand for goods and services and could potentially help the Fed with cooling down the economy in the coming months.