Fed Set To Ignore Higher Headline Inflation

December CPI Report: Headline Inflation Rises

December CPI report was in line with estimates on a yearly basis, but missed them on a monthly basis. Headline inflation continued climbing higher because of energy; core inflation continued falling despite rising medical care inflation. 

As you can see from the table below, monthly headline CPI was 0.2% which missed estimates for 0.3% and November’s reading which was also 0.3%. Yearly headline CPI was 2.3% which met estimates and increased from 2.1%. Rounding helped a bit as rounded to the hundredths place, it was 2.29%. That helps explain how it missed monthly estimates and hit yearly estimates. The same was the case for core CPI, except the rounding issue was more pronounced. It was the highest headline inflation since October 2018.

Headline inflation was driven by energy and slightly suppressed by food. Specifically, energy inflation was 3.4% and food inflation was 1.8%. Headline inflation was about 4 basis points above core inflation. It was higher than core inflation for the first time since October 2018. Energy inflation was driven by energy commodities prices which were up 7.4%. Energy services prices were down 1.2%. Fuel oil and gas were up 4.6% and 7.9%. 

Energy inflation increased; it was up from -0.6% in November. This was the first positive reading since April 2019. It was the highest reading since October 2018. As you can tell, energy caused headline CPI to rise above core CPI in that month. In the next 2 months, energy inflation is going to have very easy comps which could cause CPI to increase further.

Food inflation fell from 2%. Let’s look at what drove food prices’ 1.8% increase. Food away from home prices were up 3.1% and food at home prices were up 0.7%. Dairy and poultry had 2.4% inflation; meats, poultry, fish, and eggs had 2.3% inflation. That was counteracted by the 1.3% decline in fruits and vegetables prices. Food away from home prices are likely increasing because of the tight labor market. Full-service meals & snacks and limited-service meals & snacks had 3.3% and 3% inflation.

Core CPI Falls Despite High Medical Services Inflation

Similar to headline CPI, monthly core CPI fell 0.1% and missed estimates by the same amount. Difference was core CPI was only 0.1%. Yearly core CPI of 2.3% met estimates and was the same as last month. It just barley met estimates as it was 2.26%. It fell about 6 basis points from November and was the lowest reading since July 2019. Commodities excluding food and energy had just 0.1% inflation. 

Services less energy services inflation was 3%. Within core commodities, new vehicles and used cars & trucks had inflation of 0.1% and -0.7%. It makes sense prices are weak because demand hasn’t been strong. Electric cars put upward pressure on prices, but they are still in the low dingle digits as a percentage of total sales. Medical care commodities inflation was 2.5%.

Within core services, medical care services led the way again. Shelter inflation was 3.2%, medical care inflation was 5.1%, and transportation inflation was just 0.6%. Shelter inflation in the CPI report is based on rent prices. Shelter has the highest weighting in this report. It’s 0.1% decline to the lowest level since January 2019 kept a lid on core and headline inflation. Owner’s equivalent rent inflation was 3.28% and primary rent inflation was 3.69%. Lodging away from home inflation was just -0.28%, but it’s only 1% of CPI.

Medical care services inflation was unchanged from last month. It is still at its joint expansion high. Its 2 year growth stack rose by 0.2%. Comps will start getting tougher in May which means it might increase again in the meantime. Medicinal drugs inflation was 1.25% monthly and 2.51% yearly. 

An increase in broader medical care inflation potentially means the BLS wasn’t capturing what was increasing and instead putting it in health insurance. You can see from the chart below that health insurance inflation was still high. It increased slightly to 20.4%. Its comps will be quickly getting tougher, meaning we should see a peak soon.

Impact On Consumers & Fed Policy

Higher inflation is bad for consumers. I use headline CPI to deflate nominal wage growth. In the past 2 months headline inflation has increased 52 basis points and production and non-supervisory wage growth has fallen 59 basis points. That’s a bad combination for about 80% of workers. Specifically, headline CPI was 2.29% and production and non-supervisory wage growth was 3.03%, so at least real wage growth was still positive.

On the other hand, weekly wage growth was 2.27% which means real weekly wage growth was slightly negative. Energy inflation put a dent in real wages even though it was only 3.4%. Higher oil prices would be a big problem. Good news is even though energy faces easy comps in the next few months, oil prices face tougher comps in February and March. Plus, oil prices have recently declined from $63.27 on January 6th to $58.14 today.

This CPI report means nothing for Fed policy. The Fed is nowhere near ready to hike rates again. The market sees a cut as much more likely this year. Fed already has said it needs sustained inflation to consider hiking. A 6 basis point decline in core CPI makes the Fed slightly less likely to cut. Even though core CPI is above 2% and has been for 7 months, core PCE still is below 2%.

The chart below shows how much the Fed hiked rates if you include changes to the Fed’s balance sheet. Personally, I don’t see a recession occurring in 2020 or 2021 partially because the Fed intervened in 2019 by cutting rates 3 times. 

This chart fervently rejects the concept of the Fed hiking rates again soon which I agree with. Fed also won’t be shrinking its balance sheet anytime soon even if you ignore the effect its action to control the repo market had on its balance sheet.

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