The latest inflation data released Tuesday shows consumer prices rose more than expected in January, defying forecasts for a faster slowdown. The Consumer Price Index (CPI) increased 0.3% over December and rose 3.1% over the last year, down slightly from December’s 3.4% pace but above economist predictions.
Core inflation, which excludes volatile food and energy costs, also came in hotter than anticipated at 0.4% month-over-month and 3.9% annually. Shelter prices were a major contributor, with the shelter index climbing 0.6% in January, accounting for over two-thirds of the overall monthly increase. On an annual basis, shelter costs rose 6%.
While used car and energy prices fell, persistent strength in housing and services indicates inflation remains entrenched in the economy. This could complicate the Federal Reserve’s plans to pivot to rate cuts this year after aggressively raising interest rates in 2023 to combat inflation.
Markets are currently pricing in potential Fed rate cuts beginning as early as May, with around five quarter-point decreases projected through end of 2024. However, Tuesday’s inflation data casts doubt on an imminent policy shift. Many Fed officials have signaled a more gradual approach, with only two or three cuts likely this year.
The hotter CPI print pushed stocks sharply lower in early trading, with the Dow Jones Industrial Average falling over 250 points. Meanwhile, Treasury yields surged higher on expectations for sustained Fed tightening.
Inflation-adjusted wages also fell 0.3% month-over-month when factoring in a decline in average workweek hours. While inflation may be peaking, price increases continue to erode household purchasing power.
Shelter costs present a tricky situation for policymakers. Rental and housing inflation tend to lag other price moves, meaning further gains are likely even if overall inflation slows. And shelter carries significant weighting in the Fed’s preferred core PCE index.
While annual PCE inflation has fallen below 4%, the six-month annualized rate remains near the Fed’s 2% target. Tuesday’s data provides a reality check that the battle against inflation is not yet won.
To tame housing inflation, the Fed may have to accept some economic pain in the form of job losses and supply chain stress. So far, the resilience of the labor market and strong consumer demand has kept the economy humming along.
But the cumulative impact of 2023’s aggressive tightening is still working its way through the economy. Eventually, restrictive policy normally triggers a recession as demand falls and unemployment rises.
The Fed is walking a tightrope, trying to curb price increases without severely damaging growth. But persistent inflationary pressures leave little room for a swift policy reversal.
Rate cuts later this year are still possible, but will depend on compelling evidence that core inflation is on a sustainable downward path toward the Fed’s 2% goal. Until shelter and services costs normalize, additional rate hikes can’t be ruled out.
Markets cling to hopes that falling goods prices and easing supply chain strains will open the door for Fed easing. But policymakers remain laser-focused on services inflation, particularly in housing.
Overall, the January inflation data signals the Fed’s inflation fight is far from over. While markets may yearn for rate cuts, persistent price pressures suggest a longer road ahead before policy can substantively turn dovish.
