What To Expect From February’s CPI Inflation Numbers

CPI data for January will be released at 8.30am ET on February 14: 2023. Inflation is among the most closely watched economic indicators currently, because it is driving much of the Fed’s thinking on interest rates.

Recently, inflation has declined from mid-2022 highs, but the Fed still have concerns that inflation won’t trend back to their 2% target as quickly as they would like. Nowcasts of inflation suggest inflation could be somewhat higher than recently in the CPI data for the month of January. Recent projections imply that the Fed is currently planning to move rates a little higher than the markets expects, February’s CPI report will be a central data point in that debate. It will be important to watch core inflation and the trends in housing within the CPI.

Watch Core Inflation

The Fed’s main concern is that although headline inflation has declined, core inflation has not fallen much. Headline inflation peaked at over 9% in June 2022 and has fallen to 6.5% in December 2022.

However, core inflation, which excludes food and energy costs, peaked at 6.7% in September 2022 and came in at 5.5% year-on-year for December 2022. That’s hardly a major decline. Though headline inflation is falling, a significant driver of the decline over recent months has been declining energy prices. Core inflation has trended in a range close to 6% for the past 12 months, and the Fed is concerned that core inflation is moving “stubbornly sideways” as Jerome Powell described it in a presentation at the Brooking Institution last November.

U.S. Core Inflation, year-on-year percentage change, 2022

That said, there has been the start of a declining trend in core inflation since September 2022, as inflation has move slightly lower and pricing in many categories has eased. If that trend is sustained, it may cause the Fed to become more optimistic on declining inflation. Nonetheless, the current lack of any sharp decline in core inflation, despite encouraging headline numbers worries the Fed. Ideally for markets, February’s CPI data will show more of a robust decline in core inflation.

Nowcasts

Unfortunately, nowcasts for January inflation data are not too optimistic currently. The Cleveland Fed produces nowcasts of inflation data. These nowcasts are based on using readily available current prices to estimate the CPI report. These nowcasts see both headline and core CPI coming in at around 0.5% month-on-month in February’s CPI report. That would be above the monthly rate of inflation that we’ve seen since July 2022. However, in recent months these nowcasts have tended to overstate the rate of inflation, though their longer term track record is robust.

Housing

Shelter costs make up the largest component of CPI inflation. Although housing costs in the U.S. have softened in recent months, the CPI numbers have not reflected this. That’s believed to be due to the statistical methods to estimate housing costs used in the CPI report, which create a lag in the data. However, the timing of that lag is hard to estimate. If shelter costs do start to ultimately decline, as many including Jerome Powell anticipate, that could bring inflation much lower over the coming months. However, in the CPI report for the month of December 2022, shelter costs actually rose 0.8% month-on-month, an increase on November’s 0.6% month-on-month change. Declining housing costs in the CPI data, could be a crucial factor in driving inflation back towards the Fed’s 2% goal in 2023.

Market Impact

The Fed is looking for more persuasive data that inflation in the U.S. is coming under control from recently elevated levels. February’s CPI report could provide that, prompting the Fed to stop hiking rates sooner in 2023, perhaps holding rates steady as soon as the Fed’s May meeting.

However, oil prices are currently trending up in January, which may mean that the benefit from falling energy costs in recent inflation reports starts to wane, and nowcast data on inflation trends from January is not too optimistic either. Both the Fed and markets agree that the Fed is close to the top of the interest rate cycle, but if February’s inflation report doesn’t show continued material declines in inflation, then the Fed may add more hikes in 2023 than the markets currently anticipate.

Rates rising to over 5% is something Fed policy-makers have been quite vocal about in recent weeks, despite market expectations that we may not see rates quite that high. If February’s data is not encouraging, then markets may have to revise their current expectations that an end to rate increases is imminent.