Name: The Real Story on Inflation: Breaking Down the February CPI Report
Uploaded: 2024-03-12T14:37:00Z
Duration: 15 min 20 s
Description: Inflation continues to be the most important data point for the markets. The February CPI report sets up some tough decisions for the Federal Reserve for the rest of this year. WSJ’s Dion Rabouin explains where it all stands. Photo: Jim Lo Scalzo/Shutterstock

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Inflation continues to be the most important data point for the markets. The February CPI report sets up some tough decisions for the Federal Reserve for the rest of this year. WSJ’s Dion Rabouin explains where it all stands. Photo: Jim Lo Scalzo/Shutterstock

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The Real Story on Inflation: Breaking Down the February CPI Report

Hey everyone. Welcome, welcome, welcome, welcome in. Figured I'd do four for y'all today. Welcome to another edition of Market Takes. I'm Dion Rabouin, reporter at the Wall Street Journal. We are diving into today's CPI, Consumer Price Index, the latest look at inflation. Today's one of those days that I think requires a little bit of explanation, a little bit of extrapolation. I got the Afro out for y'all. So we're really gonna dive in and dig into this report. A lot of really interesting moves, some unexpected shifts and changes in the data. So we're gonna talk through all of that. So of course we're gonna go over what the report showed and how it compared to expectations. I'm gonna take you through that. Talk about some of the major takeaways and some of the surprises in this report. There were a lot of surprises. We're gonna talk about the market reaction, how the market moved. I think there's some really interesting things that tell you a lot about how investors are thinking about economic data right now, and especially inflation. And of course how this influences the Fed because listen, that's what it's all about. It's all about what the Fed makes of this data, not what you and I make of the data. And then of course, we'll talk about what comes next because we are always looking forward, even though this is backward looking data. So let's start things off with a chart. Let's throw a chart up here on your screen so you can see just what we're talking about. We talk about CPI. Now you see there on the right hand side of your screen, inflation had just been coming down, down, down, down. And then we got into about mid 2023 and inflation kind of got stuck. And what we're seeing from this report is inflation is still stuck. In fact, the report we got today showed inflation 3.2% CPI year over year in February. A little bit higher than expectations. Expectations were for 3.1%. Economists had predicted that inflation was gonna come in at 0.3% month over month, but it actually was 0.4%. So again, just a little bit higher than expectations. But more important than how it compared to expectations was how the CPI is moving month to month. And we see it went down in January, then it picked back up in February. And this kind of a consistent theme we've seen is where inflation is not just coming down the way it was in 2023, moving toward the Fed's 2% target. What's happening now is a little bit more unusual. The pattern is off, it's holding in right around 3%, not getting to 2%, which is the Fed's goal. And this chart just illustrating that overall we haven't seen that consistent downtrend that we were seeing last year. Let's throw another chart up here on your screen so I can show you the core CPI. Now again, what you see there is a similar thing, but a little bit more bunched up. So core CPI didn't rise as high as overall CPI and it didn't get as high, but now it's coming down and it's saying stuck right around 4%. So the core CPI is what the Fed gauges to tell them, "Okay, here's where CP is moving because it takes out volatile food and energy prices." Well, even without those, we are still seeing core CPI. We're still seeing inflation holding well above the Fed's 2% target. And this charge just illustrates that, that inflation is not getting to 2% the way the Fed wants. It's not moving in a neat, you know, fashion marching down towards 2% the way that it had been. So that may cause some folks in the market to really kinda rethink what they're doing. Core was at 3.8%, 0.4% month over month. A little bit higher than expectations for 3.7%. The big thing here that I thought was really interesting is core strips out food and gas, because they're volatile, they can move around a lot, and you wanna know, "Okay, what's actually happening with inflation When we take out these things that can really move around a lot?" Even when you take that out, you've got inflation around 4%. But what was really interesting is that gasoline was a big contributor to the overall increase in CPI this month. So gas is a big increase, but even when you take that out, core CPI is still holding above and well above overall CPI. So folks have tried to say, "Oh well, you know, it's just housing." Well now it's not just housing, now it's gas. And we'll get into that a little bit more in just a second, but I really thought this was interesting. Also, super core inflation, which is core services X housing. That was up 0.5%. Schwab's Liz-Anne Saunders saying that's about 6.9% on a three month annualized basis. That's a lot of numbers for you, but basically just means if we look at the way that that super core trend is moving right now, which Fed chair Jerome Palace singled out as being a very important metric to the Fed, that's moving pretty fast and it's moving up significantly faster than overall inflation. It's moving up faster than the Fed would like. So things to keep an eye on there. Liz-Ann Saunders, chief investment strategist at Schwab. Always a good person to follow and keep your eye on what she has to say. So listen, let's talk about the major takeaways in the report. I thought the most important number was the fact that we still have a free handle on inflation. Inflation is not getting back down to 2% on this CPI measure. But I thought the most surprising number was that thing I was telling you about gas. I wanna read to you from the report here really quickly. The index for shelter rose in February as did the index for gasoline. Combine these two indexes contributed over 60% of the monthly increase for all items. So again, now we're, it was just housing folks saying, "Okay, well, don't think about housing" But housing has consistently moved up over the past year for about the entire time that folks thought, "Oh, it's gonna come down, it's gonna start to bring CPI inflation down." It hasn't. And Brian Coulton, the chief economist at Fitch Ratings had a really interesting quote this morning after the report was released. Let's throw that chart up there, or sorry, that chart, let's throw that quote up here so you can read along. See what Brian Coulton had to say. It says, "This is a sober reminder of the tendency for inflation to perpetuate itself. Core inflation is proving to be stubborn" As you saw in that chart, holding right around 3.8%, down just a little bit from February, but the month over month rate didn't come down at all. Brian says that is not the direction the Fed wants to see. And before I take this quote down, I just wanna read one more thing that Brian said, which was a little too long for the quote, but I just wanna point it out to you. Brian points out they follow core inflation momentum, which is the three month over three month seasonally adjusted change in prices, or the change in inflation. That has actually risen. That rose in February to 3.8% from 3% in October. So what Brian is saying is this is not what the Fed wants to see. What Brian is saying is this is not showing inflation moving back towards that 2% target. And again, this just illustrating that we are not getting inflation that is being cooperative, that is doing what the Federal Reserve wants to see and what folks in the market want to see, which is inflation get back down to 2%. One other chart I wanna put up here on your screen, just while we're looking at charts. Let's take a look at CPI versus PCE. And again, you see there that divergence, PCE, which is the measure the Fed tracks most closely, has been moving down consistently in that pattern that we saw earlier in the year, or going back to last year, excuse me. CPI though is holding up. It's kind of moving down a little bit, but it's holding up there above 3%. And this charge is illustrating again, consistently we are seeing PCE come down, which is what the Fed watches, but the Fed has noted and they've said, "Listen, we watch CPI as well." That's an important inflation indicator. You can't just throw it out and say, "Oh well, you know, that's what CPI is doing." This is certainly something to watch, and what we're seeing from the data is that inflation is being stubborn. It's holding up as Brian Coulton from Fitz Ratings pointed out. PC was down to 2.4% in January. We will get the next rating in just a couple weeks, on the 29th. But this reading is showing and suggesting that it's not just housing, which we all know housing is a bigger input to CPI than PCE. Now it's starting to be gas. Gas has been overall on a year over year level dragging inflation lower. But what we are seeing is that pickup in gas prices is starting to filter in and move into overall inflation. That's gonna affect CPI and that's gonna affect PCE. So if gas prices don't continue to pull down overall inflation, if some of these other metrics like services, which has really stayed hot and really continued to move higher than overall inflation, if those things don't change, and then we start to see an acceleration in things like gasoline prices, an acceleration in things like new and used cars as we saw. If we continue to see those things, that could push inflation back higher and we could see a reversal of the progress that we've made rather than just this kind of standstill that we have seen so far. That's a big deal. But let's take a look at what the markets think and what the markets are making of this report. Let's throw up here on wsj.com and you can take a look at what's going on in markets. As you can see there, the DOW, and this happened across the indexes. This is for the DOW, the S&P 500 and the NASDAQ. You saw this exact same pattern. Market opened higher, then immediately went negative and then came back up positive. And now we're seeing each of those up about half percent, the S&P 500 and the NASDAQ. Wanna take a look at what's going on with bonds, because I think what we're seeing from that index is very interesting. Bond yields rising higher, not a big deal, but you see consistently, it's a very clear pattern. As soon as that survey comes out, bond yields just go up. And this really just illustrating the market is seeing, "Okay, inflation's not doing what we expected." Inflation's not doing what the Fed wants it to do necessarily, but there's not a lot of worry. Stock's still higher. I do think that dip you saw as soon as the market opened was interesting. Shows you that there is some worry and some uncertainty out there amongst investors that as soon as the market opened up, boom, you saw a big sell off and then you also saw some other investors come in and buy those prices back up. So I think it really is illustrative of the overall market right now, which is that when some folks are looking at the data, they're saying, "Okay, this isn't what we want to see. This is concerning, this might be showing a negative trend for the future." But then you've got some bulls out there that are just saying, "Hey, you know what? We're feeling good, we think the market and the economy are in a good place. We're gonna buy, buy, buy." There does seem to be a bit of a push and pull right now going on the markets. I think that's particularly interesting. Let's talk about how this influences the Fed, how this moves the Federal Reserve. Well, for this month, markets are basically writing off any chance for a rate cut or a rate increase. Really more than a 95% chance according to the Fed funds futures market that we do not get a cut this month. So the big question is, what happens in May, June and July? What happens in the summer? Are we gonna get that rate cut the markets are pricing in? The big worry here, I think for the market could be if inflation continues to hold around 3% and around 4% on the core side, if we don't get that movement in services, that super core inflation that Liz-Ann Saunders from Schwab talked about, if those are continuing to stay high, and again, if things like gasoline prices and oil, if things like auto insurance, if things like new and used car prices don't continue to move lower and actually start to pick up and gain some steam and move higher, that could be a thing that pushes and keeps overall inflation up. We could move from talking about rate cuts to potentially talking about rate hikes as in raising rates because as you saw, or as you will see here in just a minute, we're gonna talk about financial conditions, and those are pretty loose. But let's give you an idea of what the Fed is doing and what the Fed has done so we know where we are. Let's put a chart up here right now of the Fed funds rate, so where the Fed is holding interest rates right now. We can see that we are at the highest, on the right side of your screen, that rates have been since 2001. The other interesting thing about that though is that as you see there on the left hand side of your screen, rates in 2001 weren't holding at this level. They were coming down. It doesn't look like we're gonna be coming down right away or potentially anytime soon. As you see there from that 2005, you know, as rates were moving up there, they held for right around the amount of time that we've got now and then they started coming down as we moved into the global financial crisis. That's been a consistent theme is that as we have recessions, as the economy hits tough times, the Fed cuts rates. Well, the Fed right now is saying, "Okay, we need to hold rates higher because we haven't seen inflation doing what we want it to do." That could affect the overall economy because we know that tight or high interest rates choke off economic growth, make it harder for businesses to borrow money to get out into those public markets. Banks kind of tighten up lending and that really hurts small businesses. We've heard from small businesses and low income consumers that they've been feeling the pain for quite some time as long as this line here that you've been seeing on your screen has been going up. So this just illustrating where we've been and where we are right now, and also where history shows that we've come from. I wanna put another chart up here on your screen because we're talking about financial conditions, we're talking about how things are. Let's take a look at this. As you see there, the first thing that jumps out at you is just when those recessions happen, financial conditions go up. The numbers go up, that means financial conditions are getting tighter. Where we are right now, if you look over there on the right side of your screen, financial conditions are very loose. And if you'll notice, they're about as loose as they were when interest rates were about 0%. As we first got into that tightening cycle around 2015, 2016, that was only taking rates up to about 1%. Eventually we got up to around 2% in 2018, 2019, but then we came right back down. So historically speaking, financial conditions are very loose right now, even though rates are high. Rates the highest they've been in more than 20 years, but financial conditions are actually pretty loose. And actually, according to this data, are looser than they were before the Fed started raising rates. So again, this charge is illustrating even though rates are high, financial conditions are pretty loose. That's a lot of what you're seeing in the market. And if inflation doesn't start to come back down, which is the Fed's big piece of information, that's what the Fed is watching most closely. If that doesn't start coming back down to their 2% target, we could see conditions starting to tighten up again, start to tighten up pretty significantly. That's something you're gonna wanna watch. Listen, what comes next? We have the PPI, the producer price index, AKA, wholesale prices, AKA, what businesses are paying, that's out on Thursday. You're gonna wanna watch that because the combination of CPI, which we got today plus PPI, which we'll get on Thursday, gives you a pretty good read of what that PCE report's gonna be later this month. We also get the retail sales report that's gonna give a check-in on the economy. That's out on Thursday as well. And next week on Wednesday, March 20th, it's market takes. Hope you'll join me. We'll be right here breaking down the Federal Reserves, the FOMC meeting. They'll be making their decisions on interest rates. We'll be talking through Fed chair Jerome Powell, what everything he had to say. And for more check out my podcast, "WSJs Take On The Week." We cut through the noise to explain the major business and financial news that moves markets. Also, you can make smarter investing decisions, subscribe wherever you get your podcast. That's gonna do it. I am Dion Rabouin for the Wall Street Journal. Thank you for tuning in for Market Takes. We hope you'll come back and join us when we do it again next time.

Dion Rabouin breaks down all things finance, taking a deep dive into what’s making money move and why it matters.

The Real Story on Inflation: Breaking Down the February CPI Report

Dion Rabouin

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