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Sometimes not getting what you expect can create a very volatile reaction, even if it is a good enough substitute. I am not talking about getting chocolate and flowers instead of jewelry on Valentine’s Day, but something more mundane – the monthly inflation report. The markets and investment pundits were all set for the January year-over-year CPI rate to be below 3% for the first time in almost three years. Instead, the rate came in higher than expected at 3.1%. What was ignored was the fact that the rate was three-tenths lower than the prior reading and just one-tenth above the lowest reading since March 2021. In other words, headline inflation looks pretty good at six points below the peak in 2022 despite not being what was expected.
Stronger-than-expected shelter and core services costs boosted CPI more than anticipated. Owners’ Equivalent Rent (OER), a stand-in for housing costs, rose 0.6%, and accounted for almost two-thirds of the index. The silver lining is there is a lag effect to rental costs, and real estate analysts continue to remind us that the short supply driven price increases are coming to an end. Economists were quick to downplay the large increase with reminders that housing inflation is a smaller component in the Fed’s favored inflation indicator, personal consumption expenditures (PCE). In other words, real or not, the spike in OER will not show up in PCE, thereby hopefully translating into a lower inflation measure. Aside from housing, there remain concerns about the continued rise in core services inflation, most notably in airfares, hotels and medical care, even as core good prices keep falling.
Key Indicators this Week
Retail Sales – It should come as no surprise that spending slowed in January, especially after strong December activity. Retail sales fell 0.8%, four times more than expected. Harsh winter weather and a natural pullback in spending after the holiday season can easily be blamed. The decline was broad-based with nine of the 13 major categories posting declines. The weakness was led by the biggest drop in motor vehicle sales in over a year, along with large declines in building materials and gasoline store sales. Sparking concern was a 0.8% decline in non-store sales, the proxy for internet sales. Internet sales have been the one consistently strong category for sales until January, falling the most in 14 months. While it is easy to brush off the weak spending in January as a one-month fluke, the Fed will be closely watching future reports to determine if the spending pullback is the beginning of a trend.
Tug-of-War – Here is where the tug-of-war begins. On one side, inflation remains sticky and there is no certainty it will continue to fall – a reason for the Fed to stay firm on waiting to cut rates. The other side is hinting at weakening consumer demand that could easily spiral to slow economic growth, pointing to the need to ease policy before it is too late. The only certainty is a Fed stuck in the middle, waiting for more proof that one side won’t fall before a decision is made.
Note: Behind the Numbers will not be published next week. The report will resume on March 1.
Sarina Freedland – Senior Investment Officer
Although this information has been obtained from sources we believe to be reliable, we do not guarantee its accuracy and it may be incomplete or condensed. This is for informational purposed only and is not intended as an offer or solicitation with respect to the purchase or sale of any security. All herein listed securities are subject to availability and change in price. Past performance is not indicative of future results. Changes in any assumption may have a material effect on projected results.
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