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Disappointing Details in January CPI Report May Give the Fed Room to Maneuver

U.S. inflation may not be moderating as quickly as many were expecting.
14 February 2023

The January 2023 CPI (Consumer Price Index) data disappointed many investors and consumers: U.S. inflation accelerated on a sequential monthly basis, and now appears to be moderating more slowly than previously thought. Indeed, following the annual seasonal factor revisions and basket weights update, three-month annualized core CPI now appears to be running at 4.5% (seasonally adjusted annualized return or SAAR), notably hotter than what previously appeared to be 3.1% SAAR for the three months through December, before the revisions.

The January report did not surprise enough to change our inflation outlook for 2023. However, the combination of upward revisions to the data in previous months, the modest upward surprise in January, the extremely strong January U.S. jobs report, and the expected rebound in retail sales and industrial production are all likely to weigh on Federal Reserve policymakers. The Fed releases updated projections at its next meeting in March, and we believe another upward revision (by 25 basis points) in the median “dot” that indicates the Fed’s projected trajectory for the policy rate is now likely. This would leave the Fed’s projection for the terminal rate at 5.35% by the end of 2023. That said, projections are just that – projections – and whether the Fed actually delivers on that rate trajectory remains an open question. Financial conditions are still tight despite some recent easing, banks are tightening credit standards, and consumer savings are dwindling. As a result, while recent data suggest that the U.S. economy has been more resilient than many expected, our outlook is still for some weakening.

Inflation report details: rent, retail, cars, groceries

Core U.S. CPI rose 0.4% month-over-month (m/m) in January, similar to last month, and the year-over-year (y/y) rate ticked down to 5.55% from 5.70% in the December report. The details of the January report were mixed, with core services inflation moderating somewhat, while goods reaccelerated. Overall disinflationary trends were more muted after the Bureau of Labor Statistics (BLS) incorporated its latest seasonal factor estimates.

Core services inflation in January ticked down slightly from December (0.61% to 0.55% m/m), as the highly weighted rents and owners’ equivalent rents (OER) categories cooled. Shelter price inflation is now running at 7.9% y/y versus its pre-pandemic trend of 3%–3.5% y/y. OER and rent were both marginally softer in January after firming in December, in line with our expectations for some modest mean reversion. Alternative data on rental listing prices and rents recorded in new leases point to further disinflation ahead, and we expect these measures to peak in CPI this quarter.

In core services ex shelter, details were mixed. Medical care services prices continue to deflate after a healthy pace of price increases in 2022, as CPI-based healthcare inflation had been reflecting the strength in health insurance margins due to the lack of procedures in 2020 during the pandemic. However, those margins have since normalized somewhat, resulting in reported deflation in the broader medical services category. Elsewhere, airfares also fell largely due to the pass-through of lower energy costs. However, other categories that are more sensitive to wages remained firm, including recreation services and education. These stickier price categories appear to have peaked after the January report, but remain stubbornly elevated, something that is likely to concern Fed officials.

Retail goods prices were firm, but this was probably related to the inability of the seasonal adjustment factors to fully capture the holiday price trends. After revisions, it now appears that more discounting occurred in November and December, and therefore post-holiday sales in January appear more limited. For example, apparel price inflation was flat on average in the last three months of the 2022, only to rebound 0.8% m/m in January.

Auto prices moved in line with our expectations in January, though after seasonal revisions, the pace of new car inflation now appears more firm in late 2022 than previously reported. Used car prices fell in January, but more recent used car price auction data points to strong inflation ahead, at least temporarily. The Manheim Used Vehicle Value Index has seen some reacceleration from weakness last year. The strength in used car prices many observers had expected back in the fall of 2022 (due to hurricane replacement demand) did not materialize at that time, but we are now starting to see an apparent increase in demand amid still-disrupted supply. Since CPI tends to lag Manheim, we expect higher used car prices will likely start to affect CPI in the next couple of reports.

Headline CPI ticked down to 6.4% y/y in January, disappointing consensus expectations for 6.2% y/y. Food inflation remains stubbornly firm (0.5% m/m), as prices for grains, meat, and eggs remain frustratingly high. Energy prices also rose as expected (2.0% m/m).

Please visit our Inflation and Interest Rates page for further insights on these key themes for investors.

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