January CPI came in as expected, but under the hood, things looked much worse. Headline CPI (which includes Food & Energy prices) increased 0.5% in January, in-line with expectations. Similarly, Core CPI (which excludes Food & Energy Prices) came in at a 0.4%, which was also about in-line with expectations. Again, these are seasonally adjusted, month-over-month figures. At a high level, housing contributed about 30 of the 40 bps of Core CPI increase, services ex. housing contributed about 9, and goods contributed about 2. All of those were not far off from recently monthly figures.
Looking a few layers deeper into the onion, however, suggests some clouds on the horizon. First, the goods deflation (which to be clear means prices going down, as compared to goods prices not going up by as much, which is dis-inflation) halted its three month streak, and saw inflation again in January. This is inclusive of a fairly large decline in Used Car prices again though, which have stabilized recently. Adjusting for that, the goods numbers looked quite a bit worse, with the average goods basket about as badly inflationary as it was for most of 2021 and early 2022.
You might be asking yourself how the contribution from goods wasn't greater if the average goods category increased so much more? The answer comes from a large negative contribution (meaning tailwind to lower inflation) from Transportation Commodities (Excluding Gas). Below is a chart showing the contribution to monthly core CPI from goods both including and excluding that category, for perspective. When excluding the negative contributions from Transportation Commodities Ex. Motor Fuel, you can see that goods inflation in January was about as bad as its been post-COVID. As the 2018-19 period on the chart indicates, this number ideally will bounce around zero (so above and below) rather than simply bouncing off zero like we've seen in the last couple months.
Services Ex. Rent also presented a similar distortion. Most categories got worse month-over-month, but one category (in this case, Medical Services), helped bring down the aggregate and make it look less bad. Below is a chart showing the Services Ex. Rent monthly contribution to CPI. As you can see, this number ticked back up to multi-month highs, though still relatively in-line with historical averages. As the charts below show, however, this was largely due to a large drop in Medical Care Services, which itself was predominantly driven by health insurance (a key part of Medical Services). This kind of drop is more mechanical than fundamental, however, meaning it's unlikely we'll be able to count on this tailwind for long. Non-Housing Services outside of Medical Care Services all generally got worse this month.
To simplify, here's a chart showing Services Ex. Rent and Ex. Medical Care Services. The chart shows after several months of improvement (in this case, lower inflation, or disinflation), January showed a marked reversal of that progress.
Now here's a similar chart that we showed with Goods, with the average services category increase both including and excluding rent. This too shows broader inflationary trends across services picking up again in January after several months of improvement.
Lastly, here's the contribution from Rent, which was about in-line with recent months. As a reminder, the Rent category lags trends in the market considerably, so this is likely to reverse in coming months, though exactly when is unclear. This reversal will matter less, however, if goods and services ex. rent start inflating again at faster rates.
In summary, both goods and services saw category level inflation get quite a bit worse in January, and badly enough that they significantly impacted the three month averages. This was a large reversal from recent months. As a reminder, I like to look at the category level median and averages to get a better feel for broader inflationary trends, rather than focusing more on the overall indexes (which as we've shown above can often be distorted by large monthly swings in particular categories, like rent, medical care, or used car prices). The downtrend in recent months in the below charts was what made me feel confident we were on our way back down to 2%. This month muddies that thesis. Here's some familiar charts showing category level averages on a monthly and three-month basis, as well as a chart showing the number of categories inflating at various levels.
Lastly, here's a chart showing category level inflation by the amount of inflation that month. As you can see, after several months of seeing more categories disinflate (increasing prices but at lesser levels of increase), January showed a large reversal there.
Bottom line, January CPI was much worse under the hood than the "in-line" headline and aggregate "core" figures made it out to be. The question now is, was January's broad-based price increases businesses trying to "catch their breath" after a rough last few months of 2022? Said differently, was this a one-time catch-up in prices to account for pent-up cost increases businesses saw towards the end of last year, but didn't pass along to consumers because the economy appeared to be weakening so much? Or has the economy now simply digested all of the recent interest rate hikes and shown more resilience than anyone expected, resilience which may bring with it stickier and more persistent inflation than we thought a month or two ago? The answer unfortunately is it's too early to tell. As we've learned several times in the post-COVID era, we shouldn't be too overly reliant on one particular data point (something we may very well learn again with the January jobs report).
That being said, the breadth from which prices increased in January suggests we ought to be cautious. January is proving to be a much stronger-than-expected month economically in general, which supports the theory that businesses felt like they could catch their breath a bit and pass along some pent-up cost increases along to consumers. There's plenty of reasons to be skeptical about the economy truly re-accelerating in January, however, but as noted above, we'll have to see how the next couple of months play out before we know for sure.
One thing that seems reasonably certain is that given Fed officials have suggested they want several months in a row of good inflation reports (Fed Gov. Waller recently said he wanted 6) before they become more convinced about pausing interest rate hikes, it's quite likely that even one bad report could reverse three months of progress. Thus, the notion of three steps forward one step back may actually leave us at the same place we started from from the Federal Reserve's perspective. Said differently, Fed officials are more likely to react more negatively to bad inflation news than they are to react positively to good inflation news. Thus, while the notion of three steps forward, one step back mathematically still denotes progress, that may not be the case here. It may actually take three (or more) good inflation prints for every one bad one just to keep them from getting more hawkish and raising rates more than they already plan.
While the next Fed meeting isn't until March, markets have already (reasonably in my view) priced in more hikes between now and June, and fewer cuts later this year. The terminal rate now stands around 5.3%, with 25 bps priced in for the March and May meetings, and a slightly better than 50 / 50 chance at another 25 bps hike for the June meeting. We're clearly living in a world where things are in flux, and where more than ever, no one seems to really know what's going on. The uncertainty in the economy is as high as it's ever been (even if that uncertainty is not currently reflected in stock volatility). Thus, aggregating data points to support our arguments rather than obsessing over just one is more important than ever. Given that, we'll likely be reporting back on other inflationary data points in coming weeks like we've done in the past to help assess whether January's CPI report marked a turning point, or an aberration, in the war against inflation we're having. Stay tuned.
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