Yesterday’s US CPI report was not a block buster one way or another. The clearest message for us can be summed up as follows:
Core goods price deflation is underway: over the last three months core goods prices have fallen by 0.3%. In YoY terms core goods price inflation has fallen from a peak of 12% in February 2022 to 1.2% (Figure 1).
By contrast core service sector inflation (total services ex-energy and shelter) has only edged down slightly to 6% on the year, down from a peak of 6.4% in September (Figure 2). This is the number the Fed seems to be most focused on since they already know that shelter costs will moderate in the future. The Atlanta Fed Core Sticky CPI Ex-Shelter measure tells a similar story. In January the YOY measure fell on the month from 5.6% to 5.3% but the 3-month annualised measure has fallen from 7.2 to 3.5% per annum since May last year. (Figure 4).
These numbers won’t change opinions on the FOMC much: inflation does seem to have peaked but the sticky elements are still far above target. So the hawks will still want (at least) 50 bp of further tightening before considering a pause and no one on the FOMC seriously thinks they will be cutting rates by year-end.
Policy makers tend to be backward looking, but leading indicators of inflation should bring them some reassurance that both consumers and businesses expect inflation to fall back to normal levels in the near future. This might seem a hasty conclusion, but is strongly implied from the components of the sticky parts of inflation (Figure 2, 7). These shifts in expectations have been picked up in consumer and business surveys below.
In the latest NY Fed survey of consumer inflation expectations the 3- year inflation expectations came down to 2.7 from 3%, and 1-year was unchanged at 5% (Figure 5). The implied number for 2-year inflation, one year forward is 1.6%, down from 2%. For some months now this survey measure of consumer inflation expectations has been more optimistic than the inflation swaps market (it is usually the other way round) and suggests that consumers believe inflation will be back to “normal” in 2024 and 2025. (Figure 6). Businesses also seem to be planning for lower inflation (one of the key objectives of Fed policy): the NFIB Survey of small businesses suggests that a net positive 29% of those surveyed expected to increase prices in January (figure 7). This concurs with the regional Atlanta Fed Survey for business inflation expectations for the year ahead which has come down from a peak of 3.8% in April to 3%. Of course, this relatively benign outlook for inflation would be highly vulnerable to another energy price shock.