US CPI and the Fed’s Path Forward

February’s CPI print came largely inline with expectations, without much to push the Fed in one direction or another.

The monthly headline CPI came in at 0.4% and 6.0% y/y, inline with expectations, while core CPI (ex-food and energy) came in 0.5% m/m and 5.5% y/y, slightly higher than consensus estimates.

The biggest driver to inflation continues to be shelter/rent costs, with an 8.1% y/y gain, accounted for around 70% of the increase.¹

Airline fares jumped 6.4% on the month but this came after four straight declines and may have been linked to the rise in fuel costs at the start of the year (which is now reversing). The biggest drags came from used cars & trucks (-2.8%, the latest in a string of declines), fuels & utilities (-1.4%) and medical care (-0.5%).¹  

The number of categories printing readings above a 4% annualized run rate ticked upward (after being on a downtrend since mid last year).

I still expect the shelter component to fade as housing price drags take effect, which based on past lags should begin anywhere from next month to August.

Frustratingly, the core services ex. housing subindex ticked upward m/m and its 3-month annualized run-rate is back up again though still very much depressed versus 2022 readings. So perhaps there’s enough in here to be a “warm” report, but not hot.

2-year and 10-year Treasury yields rose a little on the release but have since relapsed. EUR/USD is now little changed.

Implications on monetary policies

While it’s encouraging to see core CPI headed in the downwards direction, the pace for improvement may be too slow for the Fed’s liking. I believe that February’s “warm” CPI print makes a strong case for the Fed to continue tightening next week. Persistently high inflation continues to be the single biggest macro tail risk.

With the FDIC guaranteeing deposits – which should place a floor on systemic risks from spreading – this should free up the Fed to continue rate hikes in order to rein in inflation.

Prior to the recent bank failures, it felt as though the Fed was erring towards a 50bp hike but I believe the choice is now closer to 25bps. I expect the FOMC to come out with very cautious with its upcoming meeting due to recent banking sector developments. 

Investment Implications

Equity markets have largely been resilient to the recent banking sector developments. The S&P 500 has largely been unchanged, though regional bank stocks have taken a beating.

With the VIX volatility index coming back to 23, the market is saying that risks are pretty much localized. I believe it’s important to assess that the market is a lot more investible this year compared to last. Despite the recent financial sector developments, overall tail risks appear more modest.