The Consumer Price Index decelerated to 3.1% y/y in January but remains above the Federal Reserve’s target level of inflation. Critically, as the y/y comparison set eases, there will be less downward pressure on the headline growth rate from a mathematical standpoint. To get CPI below 2.0% by the June FOMC meeting (May CPI will be released on June 12th, the same day as the FOMC meeting), we would have to see the m/m growth rate slow at an average pace of -0.1% over the next four months, which has only happened fourteen times (3% of total observations) going back to 1980. In the last four months, CPI has accelerated m/m by 0.1% in October, 0.2% in November, 0.2% in December, and 0.3% in January, bringing the 4-month moving average to 0.2%. If CPI was to maintain an average m/m growth of 0.2%, the headline y/y growth rate would be 2.9% for May and not move to 2.0% by year-end. While this analysis is not intended to be a forecast, it does provide a mathematical framework through which we can monitor likely incoming inflation data, which will be important to be aware of leading up to future CPI releases and FOMC meetings.
Source: Macrobond.
It is also important to remember that the Shelter component has been the primary driver of CPI growth over the last seventeen months. In the latest release, Shelter contributed roughly 90% of m/m growth and 70% of y/y growth. With that said, the pace of its positive contributions has decelerated from its peak in January of 2023. We will be watching this measure closely as the y/y upside impact of Shelter likely continues to reverse, which could be helpful in terms of bringing inflation closer to the Fed’s target level around the halfway point of the year.
Source: Macrobond.
Another series worth highlighting from this release is the All Items excluding Shelter, which decelerated to 1.6% y/y. By this measure, CPI has been below the Fed’s target level of inflation since June 2023. From our perspective, this suggests demand has mostly been decelerating, especially for items that are more related to discretionary spending. One basic example of this can be found in items like Apparel (0% y/y) and Jewelry (0.6% y/y) versus Vehicle Insurance (20.6% y/y) and Outpatient Hospital Services (8.3% y/y), the former being discretionary while the latter is more non-discretionary. This setup coupled with a decelerating positive contribution from Shelter will be important to watch over the next few months.
Source: Macrobond.
Lastly, we will continue to monitor the end-of-month average price of WTI Crude Oil, which has been a good indicator for the direction of Energy’s contribution to CPI. So far for February, the average price is $74.88, -2.59% below the $76.87 average from last February. However, the rate of change in the y/y growth rate from January into February is above the rate of change from December into January. If the recent move higher in WTI prices continues (yesterday’s close was $77.87), it would likely point toward the Energy component being less negative or even positive in the next release.
Source: Macrobond.
On the market side, Fed Funds Futures have reversed course in terms of expected rate cuts. At the end of 2023, there was a roughly 90% chance of rate cuts at the March 20th FOMC meeting. As of yesterday, that probability was down to 11%. Looking further out, the probability of rate cuts in May declined to 29% and June fell to 60%.
Source: Bloomberg.
From now until the next FOMC update, we will be tracking underlying commodity prices alongside the Fed Funds Futures market to gauge the most probable outcomes for the path of inflation and front-end interest rates.
The views expressed herein are presented for informational purposes only and are not intended as a recommendation to invest in any particular asset class or security or as a promise of future performance. The information, opinions, and views contained herein are current only as of the date hereof and are subject to change at any time without prior notice.
Investment Strategist
Boyd Watterson Asset Management, LLC