February CPI gave us both positives and negatives to digest, but on balance, this is a modestly better than expected report. Core CPI increased 0.5% month over month, in-line with expectations. Goods contributed 0 bps, Services ex. Rent contributed about 11 bps, and Rent / Shelter contributed about 35 bps. While it was an in-line report, expectations had clearly risen (to expect higher inflation) since late January as data started to come in showing an economic rebound so far in 2023 from December. In that sense, this report isn’t anything to get that excited about, because higher aggregate inflation is exactly what we got, and lower inflation is exactly what we want. Here are the key takes though as I see it:
If you’re looking at this glass half full, here’s what you’d say:
First, Services Ex. Rent continues to show pretty mild increases, though the trend isn’t exactly going the right direction. Below is the monthly contribution to Core CPI in this key category (as a reminder, this category is one the Fed is particularly focused on at the moment).
Another way to look at this is to look at the average increases across services categories more broadly, excluding rent. I do this by looking at the services categories within Sub-Indent 4. As we’ve talked about in the past, categories within Sub-Indent 4 includes a basket of 55 goods and services comprising about 98% of the core CPI index’s weight, with services being about 25 of the 55 categories. This month, similar to recent months, inflation breadth across services (excluding rent), showed increases that 1) were quite a bit lower than January’s figures 2) were also meaningfully better than at the end of 2021 and through the 1st half of 2022 3) generally in-line with pre-COVID levels and 4) generally in-line with what we’d need for 2% inflation. This is encouraging.
Second, the average and median category level increases across the entire core CPI index (so not just in the services category) returned to levels much more consistent with 2% inflation this month. After jumping to 0.55% and 0.6% in January, the average and median increase for our Sub-Indent 4 categories returned back down to 0.24% and 0.20% in February. This is a key measure of inflation breadth and is more in-line with the downward trend seen in the 4th quarter of 2022. 0.1-0.2% increases on a monthly basis is where we’d like to see these numbers, as they would produce annualized inflation not far away from the Fed’s 2% inflation target.
On the flipside, if you were looking at this report from a glass half empty perspective, here are the things that probably stood out:
First, on the Goods side, Used Car prices were again down this month, which was surprising given Manheim’s Used Car Price Index has risen noticeably in both January and even more in February on the back of tighter inventory. As you can see from the chart below, since Manheim is a wholesale based index (so it tracks prices dealers and other sellers of cars to consumers are paying for cars rather than what consumers like you and I are paying), CPI tends to lag Manheim as dealers pass through price changes to consumers. Thus, this tailwind feels poised to reverse in coming months.
Looking at Goods Ex. Cars then gives us a better trend of what goods is doing away from the mess that is the car industry. And as the below chart shows, the increase this month on a category level basis was less bad, but it is still much higher than it was towards the end of last year, and more importantly, much higher than it was prior to COVID (as we’ve talked about several times in the past, goods inflation prior to COVID was essentially zero).
Manufacturing (a proxy for goods production) appears to have been solidly in recession for several months now, but both the ISM and S&P Global’s US Manufacturing PMI reports have called out selling price increases from manufacturers in both January and February. Goods prices in the CPI in both months back this up. Despite the spending shift back to services from goods, goods inflation in aggregate is set to surprise to the upside (so higher inflation) in coming months if this doesn't reverse, especially if used car prices follow the Manheim index higher.
The second thing to point to is that while Services Ex. Rent again showed mild contributions this month, if you back out Medical Care’s negative contribution (something that is unlikely to be sustainable given it is driven by nuances in the Health Insurance Category), Services Ex. Rent’s contribution was about as bad this month as it’s been since the Fed started raising interest rates. On the one hand, you can always find one category that stands out and has outsized contributions (either positive or negative) to CPI. On the other hand, the fact that these outsized contributions are coming from health insurance, a category that is historically pretty inflationary and which is being driven by mechanically technical things in the CPI rather than market driven price declines, likely makes health insurance and medical care a bit more than a usual exception, in my view. That being said, I think a better way to look at Services Ex. Rent is the way we did it above, which was to look at average category increases across a broader basket of items. This method covers a broader array of categories and gives us a better idea of breadth in services, though it doesn’t account for the respective weights of different categories as this method does. Bought ought to be looked at and considered.
Lastly, the 3 month CPI charts, both on an aggregate core basis and on a category basis, now look much worse after the January and February reports. The Fed has already chosen to look at 6 and 12 month inflation to date, but January and February’s reversal of the progress we saw in the 4th quarter of last year will now allow them to point to little inflation improvement on a three-month basis too. This won’t make it optically easier on them to pause interest rate hikes anytime soon unless the fallout from the recent banking crises continues and proves to be significant.
In sum, this was a glass-half-full, glass-half-empty kind of report. To be sure, we’ll need better reports in coming months to have the Fed stop hiking interest rates, but assuming goods start to cooperate again, that may be more likely than not. Stay tuned.
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