Core Inflation Exceeded Expectations For The Last Two Months – Stickier Than Expected

Weekly Economic Review: March 11, 2024

Most of last week’s important financial news concerned inflation.  For the last two months, both the Consumer (CPI) and Producer (PPI) Price Indexes came in higher than expected. For now, the inflation news appears to be outweighing softening employment in terms of market impact.  Let’s review some of the more significant economic data released last week.   

Last Tuesday, the Bureau of Labor Statistics released the highly anticipated CPI for February.  The inflation data exceeded forecasts for a second month, mainly reflecting rising costs for goods after months of declines. On a monthly basis, CPI rose 0.4% as expected, but up from 0.3% in January.  On an annual basis, the index increased 3.2%, which is more than the 3.1% expectation and slightly up from 3.1% in January. Excluding food and energy costs, month-over-month the core CPI rose 0.4% in February, unchanged from the prior month, but this exceeded the 0.3% expectation. On an annual basis, the core CPI rose 3.8%, which is more than the 3.7% expectation but down from 3.9% in January.

Services prices excluding energy services declined 0.5% from 0.7% in prior month, and shelter prices, which is the largest category within services, rose 0.4%, down from 0.6% in the prior month.  However, core goods prices, excluding food and energy commodities, rose for the first time since May. 

This was followed by last Thursday’s Bureau of Labor Statistics announcement of the February PPI, showing that it rose 0.6% during the month. That was higher than the market’s 0.3% expectation and follows a 0.3% gain the month prior.  Two-thirds of the increase in PPI resulted from a 1.2% surge in goods prices, the biggest increase since August 2023. On an annual basis, producer prices rose 1.6%, up from 1.0% in January and the largest annual increase since September.  Excluding food and energy costs, the core PPI rose 0.3%, which is more than the 0.2% expectation but down from 0.5% in January.  Year over year, the core PPI increased 2.0%, which is more than the 1.9% expectation but remains unchanged from the prior month.

Also on Thursday, the Commerce Department reported that retail sales rose by less than expected after a steep decline in January. According to the report, retail sales rose 0.6% in February, which is lower than the 0.8% expectation and up from a 1.1% decline in January. On an annual basis, retail sales rose 1.5% in February, below the 3.2% increase in the headline CPI, meaning that retail sales actually fell when adjusted for inflation.  Only eight out of 13 categories showed increases.  The control-group sales, which exclude food services, auto dealers, building materials stores and gasoline stations and is used to compute GDP, were unchanged in February after declining in January.  This suggests weaker economic activity so far in the first quarter. As the Fed’s Beige Book recently indicated, consumers are becoming increasingly sensitive to prices.  The retail sales report shows that consumers are limiting their spending due to dwindling savings, high borrowing costs, and a cooling labor market.

In a similar vein, last Monday the Federal Reserve Bank of New York’s Center for Microeconomic Data released the February 2024 Survey of Consumer Expectations on inflation, labor market and household finance. The survey results show that consumer expectations for inflation remained unchanged at 3% at the one-year horizon, while increasing to 2.7% at the three-year horizon and to a six-month high of 2.9% at the five-year horizon. Consumers have less confidence about finding a job in the event of a job loss. Perceptions and expectations about credit access also turned less optimistic.

Taken as a whole, the hotter-than-expected retail and wholesale prices reinforce the notion that interest rates will stay higher for longer, until the Fed is confident that inflation is moving sustainably to the 2% target.  As a result, the 10-year Treasury yield climbed 22 basis points to 4.31% over the last week. As investors expect short-term rates to remain elevated for longer, money market funds took in a further $31 billion over the past week, reaching another all-time high of $6.11 trillion.  The recent CPI and PPI reports are the last inflation data the Fed will see before its March 19-20 meeting, where policymakers are expected to hold rates steady for a fifth consecutive meeting.  The market expectation for a rate cut in June is now down significantly, at 61.4%.  The market now expects three rate cuts this year and four in 2025. All eyes are now on the Fed’s updated projections for the fed funds rate (i.e., the dot plot) this Wednesday.  The December dot plot showed three quarter-point rate reductions this year.  The question is whether the Fed maintains that expectation or potentially revises it down due to the persistently sticky inflation.

Mark Yoon, CFA CPA
EVP & CFO of Commercial Bank of California

Thomas McCullough
EVP of Commercial Bank of California

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