What To Look For In The February Consumer Price Inflation Numbers

On March 14 at 8.30am ET we’ll learn how U.S. prices moved for the month of February. Price increases may have lessened since last summer, but there is concern that inflation may be moving sideways at well above the Fed’s 2% annual inflation goal, in part because January inflation was relatively high. That’s why markets now expect the Fed to hike further at upcoming meetings, including at the next interest rate decision on March 22.

Nowcasts

The Cleveland Fed produces nowcasts of inflation based on recent publicly observable price moves. They estimate that monthly inflation will come in at a similar level to January for February. If so, that’s not encouraging. To be consistent with 2% annual inflation, monthly inflation would need to run at around 0.1% to 0.2%. We saw some monthly reports close to that rate in the second half of 2022, however, if we see a trend of 0.5% monthly inflation then it’s clear that the Fed has more work to do, or at least will need further patience in maintaining currently high rates.

Underlying Trends

There will be several trends to watch in components of the report. The first is food costs, these are especially important for lower income groups. That’s because food costs are a necessary expenditure and have been rising at over 10% annually per January’s report. However, the rate of increase in food prices has been generally slowing and this trend may continue into February.

Housing

Housing costs or “shelter” as the CPI report terms it will be crucial to monitor given the high index weight for this category. There is a lot of industry data that house prices and rent are starting to decline since last summer, though remain up year-on-year given strong price growth during the first half of 2022.

However, declining shelter costs have not appeared in the CPI report yet, with house prices still rising month-on-month. Part of this is due to the statistical method used by the CPI to calculate housing expenditure. This introduces a lag of several months between the latest house prices and rental data and what the CPI reports.

Nonetheless, at some point in 2023 it’s likely that house prices will decline in the CPI numbers, and given the large weight given to housing costs in the index this would help bring inflation down materially. To some extent the Fed expects house prices to ease in inflation reports, so declines here would not be a big surprise, still seeing this confirmed in the data would be welcomed by the Fed.

Used Cars

Used car costs have been falling dramatically at around 2% a month recently, and though that is not a major part of the index, the sharp decline in prices is helping bring inflation a little lower. The question is how long this trend will last.

Services Costs

Lastly, the Fed will analyze the report to determine underlying services inflation. Their concern is that high wage costs are likely to keep service prices rising without further economic weakness. The CPI report isn’t the only report that the Fed uses for this analysis, but continuing price rises in the services sector will be a concern.

Policy Decisions

February’s inflation report could support the narrative that inflation may be plateauing well above the Fed’s inflation target. The more worrying implication then, is that the U.S. economy may need to see a recession, or at least slowing growth to tame inflation. That’s something that would make a so-called soft landing less likely and would mean the recent relatively encouraging jobs and growth numbers will ultimately need to weaken before the Fed thinks about dropping rates.

However, recently fixed income markets have priced in further hikes from the Fed, so even if February’s CPI numbers are discouraging, much of the negative market reaction may have already occurred. Still, it will put attention on the Fed’s March 22 meeting, when the question will be how long the Fed will continue to raise rates for, with the current expectation that rates may continue to rise into the early summer.