March 2023 CPI: Inflation Trends Remain Stubborn

Summary

• March CPI shows no incremental progress on disinflation as a smaller decrease in used car prices offset a slower increase in shelter costs.
• An ongoing recovery in rental indices suggests the progress on shelter cost inflation could be transitory.
• With low unemployment and strong demand growth, core inflation remains unresponsive to lower energy prices.

Market Implications

• I agree with markets pricing a 75% risk of a 25bp hike at the 3 May FOMC meeting.
• But I disagree with the 75bp cuts priced over the remainder of the year.

Core CPI Meets Expectations

February core CPI MoM was 0.4%, aligning with expectations, while headline was 0.1%, 10bp below expectations of 0.2% (Table 1). Relative to February, MoM shelter inflation fell 20bp, which was offset by a smaller contraction in used car prices: 0.9% compared with February’s 2.8%.

The YoY median price CPI, which is a better measure of inflation trends than core when prices are volatile, was 7.1% – down 10bp from February (Chart 1).

Core Goods Inflation Accelerated

February core goods inflation rose to 0.18% against -0.01% in January. Used car deflation slowed, which offset slower inflation in other categories (Chart 2).

Used car CPI inflation could be starting to converge on the Manheim used car auction results (Chart 3; Used Car Price Rises to End Disinflation).

Shelter Inflation Slowdown Could Prove Transitory

March shelter inflation at 56bp MoM was 20bp below February’s 76bp. However, YoY was 8.2% against 8.1% in February. Also, Zillow and Apartment List rental indices continued to rise in March, though on a non seasonally adjusted basis (Chart 4). A continuation of this trend could signal upside to the shelter CPI.

Services Inflation Ex Shelter Roughly Unchanged

March core services ex shelter inflation was 31 bp MoM against 36bp in February. Transportation inflation offset medical services deflation (Chart 5). Medical services deflation partly reflected a 4.2% MoM decrease in medical insurance costs, which itself reflects accounting conventions (Health Care Costs to Trend Higher). Excluding insurance, the MoM contraction in medical services inflation was only 7bp.

Core Inflation Unresponsive to Lower Energy Prices

In 2020, when aggregate demand was depressed and unemployment was high, transportation services and goods prices – the more energy intensive components of the CPI – were responsive to falling energy prices (Chart 6).

Now, however, with very low unemployment and strong growth, transportation and goods prices have continued to rise despite falling energy prices.   

This suggests a risk that a strong increase in energy prices could lead to a generalized increase in inflation. This is relevant given the recent OPEC+ production announcements.

Market Consequences

Wednesday’s CPI data follows Fed and commercial bank balance sheets data showing banking system stabilization. Together, the data is consistent with markets pricing a 75% chance of a rate hike at the 3 May FOMC meeting. 

Yet the CPI is inconsistent with about 75bp in rate cuts priced between May and end-2023 since the CPI projects strong pricing power that is inconsistent with an economy headed towards recession.

Dominique Dwor-Frecaut is a macro strategist based in Southern California. She has worked on EM and DMs at hedge funds, on the sell side, the NY Fed, the IMF, and the World Bank. She joined Macro Hive soon after its inception.

(The commentary contained in the above article does not constitute an offer or a solicitation, or a recommendation to implement or liquidate an investment or to carry out any other transaction. It should not be used as a basis for any investment decision or other decision. Any investment decision should be based on appropriate professional advice specific to your needs.)