CIO Notebook: February’s Not Too Hot to Handle Inflation

March 12, 2024

When combined with February’s non-farm payrolls data, we believe that the justification for a lower fed funds rate by the end of the summer remains intact.

February U.S. inflation data was released today, and the numbers came in above consensus for the fourth month in a row. Headline CPI was up +0.4% month-over-month and up +3.2% year-over-year, versus expectations of +0.4% and +3.1%, respectively. Core CPI was up +0.4% on a month-over-month basis and up +3.8% on a year-over-year basis compared with a consensus expectation of +0.3% and +3.7%, respectively.

Shelter remains the main driver in both headline and core inflation. Shelter was up +0.4% month-over-month, but was up only +5.7% year-over-year, reflecting a deceleration from December and January. Compounding the effect of shelter inflation was an increase in energy prices of +2.3% month-over-month. All of the underlying components of the energy index increased—gasoline was up a whopping +3.8%. This increase countered the prior 12-month trend, which saw energy prices fall -1.9%. Combined, shelter and energy accounted for over 60% of the monthly increase in headline CPI. Higher prices were also observed for non-prescription drugs and apparel (both up +0.6% month-over-month), used cars (up +0.5% month-over-month) and airline fares (up +3.6% month-over-month).

More constructive were flat month-over-month prints for both food and food at home indexes, which were both higher by +0.4% month-over-month in January. As highlighted in our recent CIO Weekly Perspectives, Inflation and Consumer Sentiment, the pressure on lower-income consumers as a result of sharp increases in non-discretionary spend such as food, shelter and insurance has resulted in an uptick in credit card delinquencies and slower spending. In addition, in our view, given the upcoming November election, any sustained upward price movement could have meaningful implications for both candidates, but particularly for President Joe Biden as he is likely to cite a strong economy and low unemployment as justification for his re-election.

While some economists and investors may cite the last several months as evidence of a reacceleration in inflation, resulting in a further pause in the path toward more accommodative Federal Reserve (Fed) policy, we believe there is evidence of continued downward pressure on prices across other measures, including PMIs and the non-farm payrolls numbers. With economic growth likely to slow modestly over the course of the year and wage growth past its peak, the foundation for disinflation remains solid in our opinion. We viewed this “last mile” of inflation as the hardest and, as such, expected the Fed to cut rates at a slower pace than what was priced into the market in late 2023.

Perhaps reflecting that this narrative has already been incorporated into investor expectations—or that the print was not as hot as feared—equity markets opened higher following today’s release, with the S&P 500 Index picking up +0.2% in early trading; both 2-Year and 10-Year Treasury yields moved only slightly higher in response. Fed expectations, according to the CME FedWatch Tool, are only slightly changed; the probability of a rate cut in June now sits at 66%.

In short, when combined with Friday’s non-farm payrolls data, we believe that the justification for a lower fed funds rate by the end of the summer remains intact. PPI and PCE are likely to reflect continued, if slow, progress, but we acknowledge that the recent flurry of data pointing toward a stronger-than-expected U.S. economy could result in upward revisions for both growth and inflation in the upcoming March Summary of Economic Projections.


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