The Consumer Price Index (CPI) for January reported a monthly increase of 0.60%, the same increase as December and lower than the increase in October and November. The year-over-year change increased from 7.1% in December to 7.5%. This increase in price measures is not being corroborated by other market signals and could end up being the peak for this cycle.
The recent increase in the CPI was heavily impacted by the increase in oil prices and the flow through to fuel oil (up 9.5% month over month).
Outside of the increase in energy, food prices increased 1.0%, driven by food at home (groceries), as agricultural commodities increased in January.
While these areas increased, some of the areas that drove inflation prices higher in 2021 slowed in January. New vehicle prices were flat month over month, after several increases of over 1%. Used car prices increased 1.5%, down from 3.3% in December and 2.5% in October and November.
Shelter has also been a large contributor to the increase in the CPI. In January, shelter increased 0.30%, down from 0.40-0.50% over the last few months.
The comparison set for the CPI will likely get more challenging after the month of February, as the increases in March-May 2021 were partially driven by the weakness in the same period in 2020 and the large fiscal actions in March 2021. The opposite conditions will be in place in 2022, with more difficult comparisons and no new fiscal support. This is true at the index level and the components that have been leading to high index levels.
This more difficult comparison set increases the probability that the rate of change for the CPI will slow in the coming month and the absolute growth rate may eventually turn negative.
There are other market based indicators for measuring inflation that have not been increasing alongside of oil and the CPI. The five and ten-year TIPS breakevens both peaked in November 2021 and are over 0.30% below their highs.
Five and ten-year Inflation swaps also peaked in November 2021 and are 0.30% below their highs.
The interest rate market is also sending signals that inflation will likely not continue to accelerate.
The U.S. Treasury curve continued to flatten last week. Most of the flattening is being driven by a large move in short-term rates (under two years) and a correspondingly lower increase in longer-term rates (over five years). Shorter-term interest rates are more sensitive to changes in Federal Funds Rate target range, which is determined by the Federal Open Market Committee (FOMC). The expectations for the Federal Funds Rate have been increasing recently, based on comments from FOMC members and the recently reported CPI. The market expectations for one-month rates one year from now ended the week at 1.90%. Longer-term interest rates are more sensitive to changes in growth and inflation expectations. The fact that these interest rates have been increasing by less than short-term rates (flatter curves) is an indication that investors expect the rate of change for economic growth and inflation to slow in 2022.
While the expectation for short-term interest rates in 2022 has been increasing, the expectations beyond 2022 have been decreasing. The expectations of one-month rates two years from today is only 0.03% higher than the one-year level, and the three-year level is 0.10% lower than the one-year level (0.13% lower than the two-year level). The Eurodollar futures curve has also started to decline as near-term expectations for three-month rates have increased while longer term expectations have decreased. The near-term portion of the curve started to invert at the end of last week. These movements in short-term interest rate expectations suggest that investors expect the FOMC to increase interest rates in 2022 but not beyond that, and they may need to start lowering interest rates shortly afterwards.
The movements in market signals suggest that the increase in the CPI is not a sustainable trend and that the expectations for future inflation growth is declining. If the FOMC does increase interest rates at the currently expected pace in 2022, the expectations for economic growth and inflation are likely to continue to decrease, leading to flatter and potentially inverted curves.
Vice President, Research and Strategy
Boyd Watterson Asset Management, LLC
Vice President, Research and Strategy
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