US CPI report comes in stronger than expected
Although the overall softening inflationary picture remains unchanged, a March interest cut is now seen as effectively ruled out
Annual headline CPI rises from 3.1% to 3.4%, monthly rate rises from 0.1% to 0.3%
Annual core CPI dips from 4.0% to a new cycle low of 3.9%, monthly rate remains unchanged at 0.3%
Overall disinflationary big picture remains intact, but further evidence of CPI definitively slowing will still be needed by the Fed before it will contemplate a shift in policy
But in reality, for the FOMC it is all about the forthcoming core PCE numbers
CPI report disappoints on the strong side
A stronger set of inflation numbers from the US today, the annual headline rate rising from 3.1% to 3.4%, surprising the market which had been expecting a reading of closer to 3.2%. On a more positive note the annual core rate fell to 3.9% from 4.0%, a low for the current cycle, but disappointingly the monthly rate remained unchanged at 0.3%. Overall the numbers are unlikely to convince the Fed that inflationary pressures are definitively slowing, the market recognising this by moving to rule out the chances of an interest rate cut being seen as soon as March and leaving May now as the first opportunity the Fed might have to lower the cost of borrowing.
Core services prices rising; core goods prices falling
Of particular concern to the Fed will be the fact that the core non-rent services component rose by 0.4%. Despite falling sharply since H2 2022 and over most of 2023, the series has stabilised of late showing remaining inflationary pressures to be stubbornly resisting the Fed’s attempts to bring them lower. Indeed, much of this stubbornness is now seen stemming from the resilience being seen in the wages growth numbers, something over which the Fed has no real control and which are typically the most significant cost item for firms in the services sector. This will do nothing to dispel any lingering fears the Fed maintains regarding the potential for the labour market to push CPI away from its target. Accordingly, further downwards movement here will be dictated by the pace of compression being seen in retail margins and the slower wages growth expected over the course of 2024, which together suggest progress may be slow. Core goods prices were unchanged, with declines in items such as furnishings and computers offsetting the rises seen in vehicle prices. Remove vehicle sales from the numbers and goods prices actually fell 0.2%, the third such decline over the past four months.
But for the Fed it's all about the PCE numbers
Overall today’s report does not really change the inflationary picture. Core goods prices are still heading lower, core services inflation remains sticky and increases in housing costs are still being seen but slowing. However, it should be remembered that the Fed pays much more attention to the core PCE numbers than it does the CPI figures and as such it is therefore probably prudent to wait for the release of the PCE numbers on 26th January before making any cast iron predictions about the Fed’s policy stance over the near-term. Indeed, it is not uncommon for the core CPI and PCE figures to diverge from each other monthly: the November PCE reading of 0.06% was accompanied by a core CPI reading of 0.29%. As such, while the spread between the December figures may prove not to be as wide as November’s numbers, it remains a fair bet that the forthcoming December PCE numbers will print lower than their CPI equivalents. While this will probably not be enough to resurrect the chances of a March interest rate cut being seen, it could well reinforce expectations for a May cut.
Important message is that the Fed is done with raising rates further
Given the response seen in the markets to today’s report, the conclusion is that it had got a little carried away with itself in expecting an interest rate cut as soon as March. Overall, today’s numbers are not necessarily bad; rather they show that progress in bringing CPI back to its 2% target is going to take some time and is not going to be something that is achieved in a straight line. The most important message is that the Fed is done with raising rates any further. Whether the first cut comes in March, May or June, and whether we get 100bps or 75bps of cuts this year, is not really that relevant in the grand scheme of things. Of most importance is that CPI is returned to target in a timely manner and that a recession is avoided; and on both these counts the Fed appears to be doing a competent job so far.
The most important message is that the Fed is done with raising rates any further. Whether the first cut comes in May or June, and whether we get 100bps or 75bps of cuts this year, is not really that relevant in the grand scheme of things.