US inflation update for January
The US CPI figures were stronger than expected last month. Headline inflation rose by 0.5%, pushing the annual rate back to 6.4% from 6.2%, while the core rate of inflation increased by 0.4% last month, with the annual rate rising by 5.6%, up from a 5.5% annual growth rate in December. Shelter costs were by far the largest contributor to the all items increase, accounting for half of it. Food and energy prices were also higher last month, according to the US Bureau of Labour Statistics.
The inflation report has weighed on risky assets, and US indices are reversing their gains from Monday. The S&P 500 is down some 0.8%, while the Dow is lower by more than 1% at the time of writing. The Nasdaq is also lower. The USD is the second-best performing currency in the G10 FX space on Tuesday, while the 2-year US Treasury Note, which is sensitive to changes in US interest rate expectations, is up 11 basis points, to 4.65%. The initial market reaction appears to be that, combined with the stronger than expected jobs report in January, the Fed will have to keep rates higher for longer, and the much-awaited pivot will need to be pushed further into the future.
Super core inflation
However, when it comes to inflation, it is important to dig deeper into the data. The overall CPI report is weighted towards energy, shelter, food, transportation, medical and educational service costs, which are all volatile. For example, energy and food prices change daily, while transportation, medical and educational services can be impacted by union activity and seasonal factors. Thus, the Fed has started to look at a ”super core” measure of inflation, which is a narrower slice of the US price data and is considered to give a more accurate view of inflation in the US economy. While the components of super core inflation have not been officially defined, the economist Paul Krugman has defined super core as excluding food, shelter, energy and used car prices. These are volatile sectors that can be impacted by supply chain disruptions etc. The former Secretary of the Treasury, Lawrence Summers, says that labour and wage cost indices are more important than the CPI, as a tight labour market forces companies to pay higher wages that can then create a wage-price spiral.
Thus, when it comes to determining how this inflation report could change the dial for the Federal Reserve, it is worth looking at price growth in the service sector. High service sector inflation sends a signal to the Fed that wage growth is continuing to put upward pressure on prices, which may require more rate rises. Below we look at the key service sector price increases for January that we think are worth watching:
Food away from home (full-service restaurants): +0.5%
Alcoholic beverages away from home: +0.6%
Professional services: +0.1%
Recreation services: +0.7%
Pet services: +1%
Club memberships: +0.5%
Miscellaneous personal services (inc. legal, funeral expenses, laundry, and dry cleaning): +0.8%
This may not be an exhaustive list; however, it has some interesting developments. Firstly, these prices continue to rise at a monthly rate that is mostly above the headline CPI rate. Secondly, there have been no price declines in service sector inflation, which suggests that there is not yet disinflation in the US economy. Lastly, restaurants seem able to put their prices up, something that would be unlikely to happen in a weak economy. Likewise, if inflation is rising in club memberships and recreational services, it doesn’t suggest that the consumer is cutting back. Analysing these specific price increases suggest that the US economy is strong, the consumer is confident and spending is being fuelled by decent wage growth.
Is there a wage/ price spiral?
This data is somewhat contradictory compared with the BLS’s Employment Cost Index for Q4 2022. This report showed that wages and salaries rose 1% in Q4, slower than the 1.3% increase recorded in Q3 2022. However, a strong consumer could be sustained by 1, the compounded impact of wage increases throughout 2022 and 2, drawing down on savings that were accumulated during the pandemic. Although the US personal savings rate has declined in recent months, it rose in December compared to November, rising 3.4% compared with a personal savings rate of 2.9% in November. Thus, Americans could be spending “excess” savings from December at the start of the new year. We shall have to see if this boosts the US retail sales figures for January that are released later this week.
Bonds steal the limelight from stocks, for now
Overall, last month’s inflation data makes it harder for the Fed to call time on rate hikes, which makes it difficult for risky assets to rise in the short to medium term. Government bond yields are also rising close to their highest level since 2008. This may also entice stock buyers to the safety, and high yields, of bond markets for the foreseeable future.
There has been a rapid re-pricing in the Fed Funds Futures market (the infamous WIRP chart!) It now sees rates peaking at 5.28% in July, with only 30 basis points of rate cuts now priced in by the end of 2023/ start of 2024, as you can see in the chart below.
Chart: US WIRP
