Posted by Jeffrey J. Roach, PhD, Chief Economist
Tuesday, February 14, 2023
The Uneven Path
For most categories, inflation is decidedly past peak. But as we see from today’s report, the pathway back down to the Federal Reserve’s (Fed) target of 2%, will be choppy. In January, the U.S. Consumer Price Index (CPI) rose 0.5% from a month ago, driven up by shelter costs. Higher shelter costs contributed roughly half of the monthly gain in prices during the month. Other contributors to the upward rise in prices were groceries, restaurants, and energy costs.
Not all categories rose during the month. Medical care services fell for three out of the last four months. Used cars and trucks also continue to decline. In a dramatic reversal from the previous years, used cars and truck prices are down over 11% from a year ago.
Overall, the annual inflation rate dipped down to 6.4% in January from 6.5% the previous month. The annual rate is now the lowest it has been since October 2021, as shown in the chart below. Revisions showed inflation was slightly hotter than initially reported, and adding risk that a resurgence in pricing pressures is a possibility if demand does not adequately slow.
As the global economy is in the process of finding balance, investors should expect a bumpy ride back down to pre-pandemic inflation rates. Because some sectors are still recalibrating, the risks are high that inflation does not come down as fast as the markets expect.
Where are the Risks?
The two main risks in the markets right now surround China and the domestic consumer. First, investors should carefully watch the reopening process in China. If the Chinese economy grows faster than expected, global inflation–and by extension U.S. inflation–could run hotter for longer than expected. Second, the strength of the labor market implies consumer demand could stay elevated this year. The Fed communicated there is more work to do in raising rates, so the risk for this year is that higher rates might not slow consumer demand enough for inflation to ease consistently.
What Does This Mean for You?
As of 2023, the Bureau of Labor Statistics (BLS) is now updating the spending weights within the CPI report every year instead of every two years. The goal is to have a more accurate measure of pricing pressures on the average household, but the CPI improvements will not likely change the Fed’s preference for the deflator from the Bureau of Economic Analysis (BEA) personal income and spending report.
Most relevant for the average consumer, rising prices mean lower purchasing power. Adjusted for inflation, real average hourly earnings fell 1.8% from a year ago. For many people, wage growth has not kept up with inflation, eroding purchasing power for many Americas.
Inflation is easing but the path to lower inflation will not likely be smooth. The Fed will not make decisions based on just one report, but clearly the risks are rising that inflation will not cool fast enough for the Fed’s liking.
Looking ahead, rents should be less of a driver for inflation as new rent prices have declined for the last several months and should eventually filter into the official inflation statistics from the BLS.
Globally, investors should know that China’s growth path for 2023 puts upside risk to inflation expectations. But according to the University of Michigan’s benchmark survey, long-term inflation expectations are well-anchored at 2.9%, unchanged for the third consecutive month and this supports the view that the Fed will hike by 0.25% at the next meeting and not revert to larger rate hikes.
Not all risks are to the upside. If the economy can boost productivity this year, we could see a repeat of the 1990s when core services inflation fell despite higher labor costs. For more on the role of productivity growth in softening sticky inflation, watch this week’s Econ Market Minute here.
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