U.S. CPI Drops Slightly In January, But Fed Now Expects Higher Rates For Longer

Key Takeaways

• Year-over-year inflation cooled slightly in January, but less than economic experts forecasted
• Monthly inflation painted a more concerning picture, with shelter, food, gas, and clothing posting significant price increases
• Fed Chair Jerome Powell stated last week that the Fed’s goal of 2% inflation is “likely to take a bit of time”
• Comments from Federal Reserve members have prompted markets to believe that the Fed is unlikely to stop hiking interest rates until at least a range of 5.25%-5.5%

This Tuesday, the U.S. consumer price index (CPI) reported a slightly smaller decrease in annual inflation than was forecasted by economists. Tuesday’s CPI report marked the seventh consecutive month of annual inflation cooling off following June’s 9.1% high. Looking at the report in more detail, though, it isn’t necessarily clear skies ahead.

The consensus expectation among economists for Tuesday’s annual CPI was 6.2%, down from December’s 6.5%. However, the data showed inflation slowing slightly slower than this forecast, with an annual increase of 6.4% in January.

Core CPI – an index that excludes food and energy items due to their volatility – also failed to meet forecasts, reporting a 5.6% annual increase against its 5.5% economist expectation.

With various items in this month’s CPI reports printing monthly increases, it’s becoming increasingly clear that despite inflation coming down in recent months, the U.S. is far from out of the woods. The Federal Reserve’s target inflation of 2% could take a while to reach, and costs of living are likely to continue to fluctuate on the way there.

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Monthly inflation shows signs of stubbornness

Looking more closely at Tuesday’s CPI report, several items showed price increases on a monthly basis. Energy, in particular, reversed a declining trend from the previous two months. While this is excluded from core CPI, it does cause a negative impact to headline CPI.

Food and clothing prices grew more quickly than in December, reporting 0.5% and 0.8% monthly increases respectively. Shelter, while slowing in price growth from December, still rose 0.7% on a monthly basis.

Hopefully, shelter inflation is past its peak, but it still presents a difficult situation for households across the country, eating into their disposable incomes.

Looking over to other categories in the CPI report, we see that transportation services, hotels, and car insurance all continued to see sharp monthly price increases in January. Certain items, such as new and used vehicles, did see drops in price, contributing to overall monthly inflation coming in slightly lower in January than in December.

Services inflation – which includes healthcare, rental costs, restaurant meals, beauty treatments, and other non-goods – has continued to grow rapidly and shows no signs of slowing down. The Dallas Fed’s president Lorie K. Logan acknowledged on Tuesday that while there has been progress on inflation, services inflation needs to slow.

On the whole, January’s CPI report highlights the fact that the current inflationary pressures are stickier than members of the Fed initially suggested last year. Just last week, Fed chairman Jerome Powell said, “There has been an expectation that it will go away quickly and painlessly – and I don’t think that’s at all guaranteed.”

The Fed’s ongoing fight against inflation

Since March 2022, the Federal Reserve has raised interest rates from practically zero to their current range of 4.50%-4.75%. This is the most aggressive series of rate hikes since the 1980s.

As CPI data has shown inflation to have peaked last June, the Fed has since taken its foot off the brakes. However, it’s far too soon to declare this battle a victory. Fed members have expressed that before they pause the tightening cycle, they’d like to see diminished price gains across the board, and a softer labor market.

Earlier this month, the non-farm payrolls report showed that the U.S. economy added more than half a million new jobs in January. This put the country’s unemployment at 3.4% – the lowest it’s been since 1969.

This strength in the economy underlines the challenge the Fed is faced with. Until the labor market shows signs of weakening, demand is likely to stay high, and the Fed will need to continue hiking or maintaining restrictively high interest rates.

Additionally, the reopening of the Chinese economy is expected to put pressure on global demand, causing concern among fund managers globally that inflation may stubbornly remain “higher for longer.”

John C. Williams, the New York Fed’s president and CEO, said on Tuesday that a year-end federal funds rate of 5.00%-5.50% seems reasonable. This shows us that Fed members acknowledge that inflationary pressures may linger longer than they initially hoped. Just a few months ago, Fed officials projected a terminal rate of 4.6%, and this has steadily crept up.

The bottom line

January’s CPI data showed a marginal drop in annual inflation. While this is positive news on its own, this was a weaker drop than experts forecasted, highlighting that the fight against inflation hasn’t been won.

Economic factors, such as the immense resilience of the U.S. labor market and the reopening of the Chinese market, mean that demand for goods is unlikely to slow substantially. This makes inflation unlikely to go away quickly and quietly.

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