Evening Brief – 03.12.24

Stubborn

The headline consumer price index (CPI) increased 0.4% in February, the most since August, due to higher energy prices, reported the U.S. Bureau of Labor Statistics (BLS) on Tuesday. The annual CPI inflation rate increased to 3.2% from 3.1% in January, slightly exceeding expectations of a steady 3.1%.

Core CPI rose 0.4%, exceeding the 0.3% expectation. Annual core CPI inflation fell to 3.8% from 3.9% in January, missing estimates of a drop to 3.7%. Core goods prices increased by 0.1% month on month, while core services prices increased by 0.5%, a slower rate than in January.

Meanwhile, the 3-month annualized rate increased to 2.8% from 1.9%, while the 6-month annualized core rate fell to 3.2% from 3.3%.

“The index for shelter rose in February, as did the index for gasoline. Combined, these two indexes contributed over sixty percent of the monthly increase in the index for all items,” the BLS noted. “The energy index rose 2.3% over the month, as all of its component indexes increased.”

While it is possible that the market anticipated a rise in inflation in February, which explained the rally in the equity markets and decline in bond yields, it is likely to be concerning for the FOMC given overall inflation remains stubborn.

“This will probably be seen as a reason to keep policy on hold a while longer. Through the volatility, the downtrend in inflation seems to be leveling off and the Fed would like to see it continue to move lower before easing rates,” explained Kathy Jones, Charles Schwab’s chief fixed-income strategist.

The positive development is that the owners’ equivalent rent, which is an essential component of the Fed’s primary inflation rate, increased by 0.4% this month, down from 0.6% in January.

“The hot core CPI reading won’t build Fed confidence to cut rates imminently, but it also doesn’t rule out the chance of a mid-year rate cut. More importantly, the reversal of the unusual spike in owners’ equivalent rent showed January’s reading was likely just an aberration, not a signal of stickier housing inflation,” said Anna Wong, Bloomberg Economics:

Another element that appears encouraging for the Fed’s rate-cut prospects is that following a 0.5% increase in January, prices for food away from home increased by only 0.1%. Food service prices are not included in the core CPI, although they do appear in the core PCE price index – a closely watched metric by the FOMC.

Following the CPI inflation print, the markets were pricing in a 14% chance of an interest rate cut on May 1, down from 20% prior to the release. However, the probability of a cut at the June 12 meeting remained at 68%, unchanged from before the CPI data was released.

For the year, investors expect the Fed’s benchmark rate to end at 4.52%, up from 4.49% ahead of the CPI. Current probabilities suggest that four quarter-point rate cuts are about as likely as three cuts from the Fed’s current target range of 5.25% to 5.5%.