February 16, 2024 – Data released on Tuesday showed that consumer prices increased by 3.1% in January from a year earlier.[1] Though a decrease from December’s 3.4% number, January’s reading was above the economists’ consensus projection of 2.9%.[2] Investors reacted strongly, sending stocks lower and bond yields higher, though by Wednesday, both markets saw a modest recovery. A deeper dive into the inflation report suggests that the battle against inflation continues to progress well, but also validates the Fed’s messaging that more data is needed before they begin to cut rates.
Despite the higher-than-expected topline inflation number, only a small number of sectors contributed to the annual increase, chief among them restaurants, housing, and transportation (see chart 1). This first won’t surprise anyone who has eaten out in the past year and is likely due to increases in labor costs. Higher transportation costs result mostly from increases in car insurance and auto repair costs. Here, too, a shortage in car mechanics and the increased cost and complexity of cars seems to be driving insurance rates higher.
That brings us to housing, which, at 36% of the total weight of the CPI, is one of the largest contributors to January’s reading and is also one of the hardest items to measure. The Bureau of Labor Statistics (BLS) collects data on rents and owners’-equivalent-rent from a large sample in which households are visited every six months.[3] Beyond the challenge of establishing rent equivalency, this methodology results in a significant reporting lag. As can be seen in Chart 2, an analysis conducted by the Brookings Institute shows that CPI rent has been lagging other rent indexes like the Zillow Observed Rent Index and the CoreLogic Single Family Rent Index since early 2022, both on the way up and on the way down.
Housing and other reporting lags are likely why the Fed is insisting that more data is needed before they begin to lower rates. The Fed is undoubtfully disappointed that the inflation number did not begin with a 2, but then again, it’s been consistently messaging that inflation can be persistent. The vast majority of investors now agree that the Fed is unlikely to cut rates in March, although over 80% still expect a rate cut by June of this year.[4] If his recent history is a guide, this prediction, too, is likely optimistic.
In all, nothing in Tuesday’s report is cause for immediate concern, though it emphasizes the difficulties both in lowering and measuring inflation. Importantly, the likely direction of interest rates is still downward, if at a slower pace than investors would like. Still, rates could come down in a hurry if the economy hits an unexpected speed bump, so now is a good time to lock in these higher rates.
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[1] https://www.bls.gov/cpi/#:~:text=In%20January%2C%20the%20Consumer%20Price,over%20the%20year%20(NSA)
[2] https://insight.factset.com/consumer-price-index-cpi-for-january-2024-is-projected-to-rise-2.9-year-over-year
[3] https://www.brookings.edu/articles/how-does-the-consumer-price-index-account-for-the-cost-of-housing/
[4] https://www.cmegroup.com/markets/interest-rates/cme-fedwatch-tool.html, retrieved 2/14/24
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