We received the first inflation report for 2024 on Tuesday this week, and by most accounts, it was disappointing. Since inflation continues to be the litmus test by which the Fed will determine its rate policy, it will be critical to see the progression over the next few months. Headline inflation dropped to 3.1%, but well ahead of the 2.9% expectations. Core inflation remained steady at 3.9% but well ahead of 3.7%, the anticipated number.
Housing continues to be the primary contributor to overall inflation and the reason for the above-expectation inflation print for January. Shelter accounted for over 2/3 of the total increase in inflation. Over the last year, one-month spikes have distracted from an otherwise clear trend of slowing shelter inflation. This month was no exception, as the monthly change in shelter jumped higher. However, the expectation is that housing inflation will continue to decline in aggregate over the next 6-12 months (see the lagged impact between high-frequency rent data versus CPI).
Now, to be clear, shelter is not the only inflation component. It has just gotten a lot of attention due to its outsized impact and the apparent disconnect between current data and what is showing up in official figures. With that said, there are still pockets of concern from this month’s report, including motor vehicle insurance (+18%), medical services (+9%), and food (+5%), all up considerably on a month-over-month annualized basis. We are certainly not out of the woods yet on inflation, so it will be interesting to see how the Fed reacts.
To that point, earlier this year, we discussed how the market was pricing in six rate cuts versus the Fed estimating three. We noted one of the parties would be wrong, and the market was perhaps getting ahead of itself. It’s incredible how quickly things can change, with the market now pricing in just four rate cuts this year. Moreover, one month ago, markets had a 77% probability of a cut in March. After the January inflation numbers, that is now down to 6%.
If there is any positive news, January can be a particularly tough month for producing actionable insights from CPI data. Why is that? First, in January, many businesses make price changes, adding volatility to the aggregate numbers. Second, and perhaps more importantly, each monthly report is “seasonally adjusted” to account for the “known” trends from month to month. However, seasonal adjustment factors are recalculated with the release of January CPI. While important for monthly comparability, this process also imparts another significant hard-to-forecast variable into the equation.
Due to this, some economists also like to look at “unadjusted” CPI to gain a more nuanced view of the information. As you can see in the chart below, unadjusted month-over-month inflation tends to be higher in January and trend down throughout the year. While the January 2024 numbers are still higher than 2018/2019, they were well below 2022/2023, implying that we’re still moving in the right direction. Moreover, it continues to highlight the difficulty in factoring in seasonal adjustments.
All of this to say, while the inflation report was not what we hoped for and not what many expected, it is still just one month. And it will take more than one month of data to change what is a clear disinflation trend.
Economy
- Markets were volatile after the Tuesday inflation report with the S&P 500 down -0.4%, the Nasdaq down -1.3%, and the small-cap Russell 2000 up 1.1%.
- U.S. retail sales shrank 0.8% MoM in January, reversing from a downwardly revised 0.4% rise in December and worse than market forecasts of a 0.1% fall.
- U.S. individuals claiming unemployment benefits fell by 8K from the prior week’s upwardly revised value to 212K for the period ending February 9, firmly below market estimates of 220K.
- Producer prices for final demand (PPI) in the U.S. were up 0.3% MoM in January, the biggest increase in five months, following a 0.1% decline in December. The cost of services rose 0.6%, the largest increase since July.
Stocks
- U.S. equities were in negative territory. Technology and Consumer Discretionary led the decline, while Energy and Materials outperformed. Value stocks led growth stocks, and small caps beat large caps.
- International equities closed higher for the week. Emerging markets fared better than developed markets.
Bonds
- The 10-year Treasury bond yield increased 11 basis points to 4.30% during the week.
- U.S. bond markets were in negative territory this week, while International bond markets were positive.
- High-yield bonds led for the week, followed by corporate bonds and government bonds.
