Timely and Relevant News: Inflation Shifts Fed Expectations
Should we really be surprised about inflation at this point? The Consumer Price Index (CPI), the most well known measure of inflation, climbed 7.5% over the last year through January - its highest reading since 1982.
The “core” inflation reading, which excludes the more volatile food and energy components, also continued to climb - hitting 6.0% year over year.
As shown in the chart below, the three-month annualized run rate for inflation is still running higher than the one-year number, as it has 18 of the last 19 months. Seeing that reverse will be an important sign that inflation is coming under control.
“This CPI reading was all about the Fed for markets and the surprise was big enough to keep an aggressive rate hike path in play,” said LPL Financial Asset Allocation Strategist Barry Gilbert. “While inflation may start getting better from here, market anxiety about potential Fed overtightening won’t go away until there are clear signs inflation is coming under control.”
S&P 500 sold off following the release, the 10-year Treasury yield climbed and Federal Reserve (Fed) rate hike expectations tilted more aggressive. Market-implied expectations are about even money for a 50 basis point (0.5%) rate hike at the Fed’s March policy meeting, although several Fed members have said it’s not their base case and economists’ expectations are more muted.
If there’s a positive takeaway from the report, it’s that new vehicle prices were flat. There are still some components of CPI that have seen extreme price gains over the last year that are not expected to persist, with new and used vehicle prices having the largest impact. Those categories alone could account for about a 0.5% decline in core CPI in the long run as they normalize and even more temporarily if they see price declines before leveling out.
The Fed’s goal now is to convince markets it can get inflation under control without overtightening. It’s a delicate balance and one that the Fed has historically had trouble getting right in real time. However, mistakes have usually come when we’re deeper into the cycle and early rate hikes are rarely a problem. The Fed will get one more look at CPI inflation next month before its March 15-16 meeting.
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All index data from FactSet and MarketWatch.
This Research material was prepared by LPL Financial, LLC.