Consumer price index data for January showed that core inflation ran hotter than expected, with services prices rising at the fastest pace since September 2022. After the CPI inflation data, the S&P 500 fell sharply in Tuesday stock market action. Markets came close to pricing away one quarter-point Federal Reserve rate cut after the data.
CPI Inflation Report Hits And Misses
The overall consumer price index rose 0.3% on the month, above expectations of a 0.2% rise. The 12-month CPI inflation rate eased to 3.1% from 3.4% in December, exceeding 3% forecasts.
The core CPI, which strips out volatile food and energy prices, rose 0.4% vs. December levels, above 0.3% estimates. The annual core CPI inflation rate unexpectedly held at 3.9%, above forecasts of 3.7%. The core CPI inflation rate peaked at a 40-year-high 6.6% in September 2022.
Core goods prices fell 0.3% on the month, which was the biggest drop since July, but core services prices rose 0.7%.
Part of that was housing, with shelter costs up 0.6%, including a 2.4% jump in motel and hotel rates. Meanwhile, transportation services prices climbed 1%. Prices for food away from home rose 0.5%, the biggest rise since May. Prices for inpatient and outpatient hospital services jumped 1.8%, the biggest monthly rise since October 2015.
CPI Vs. PCE Price Index
Keep in mind that the Fed's primary inflation rate, the core PCE price index, showed much tamer price pressures than the core CPI over the second half of 2023 — 1.9% vs. 3.3% at an annual rate. So the current rule of thumb for looking at CPI data is that monthly increases around 0.2% are good news and 0.3% increases may still be fine, depending on how things look below the surface. A 0.4% rise might not be great, but may not be awful. We'll know more on Friday.
The difference between not great and awful may come down to what Friday's producer price index shows about health care prices, since that data feeds into the PCE price index. Lately, PPI health care inflation has been much softer than CPI health care data. That partly reflects CPI data on health insurance, which is a poor real-time measure. Also, CPI data is based on out-of-pocket spending, while PPI data includes employer and government reimbursements to medical providers.
Deutsche Bank economists noted this week that a 3.4% reduction in Medicare physician reimbursements could hold down health care inflation in January.
On the other hand, there's some risk that the PPI will show a big increase in portfolio management fees, which typically rise with stock prices but haven't kept up lately.
Fed Rate-Cut Odds
After the CPI inflation data, markets were pricing in just 8.5% odds of a Fed rate cut on March 20 and 36% odds of a cut by the May 1 meeting. Odds of a rate cut by June 12 now stand at 74%, down from 92% on Monday.
For all of 2024, markets now see the Fed's key rate ending the year at 4.49%, up 24 basis points from 4.25% ahead of Tuesday's CPI data.
Current odds imply that four quarter-point rate cuts are roughly as likely as three cuts from the current 5.25% to 5.5% range of the Fed's key rate.
S&P 500
The S&P 500 slid 1.3% on Tuesday after the CPI inflation data. On Monday, the S&P 500 inched down 0.1%, after closing at a new record high on Friday.
Strong economic data, a major stock market rally and Fed policymakers' doubts about whether monetary policy is really that tight had conspired to push up Treasury yields prior to the CPI report, with the 10-year Treasury yield testing the high end of its recent range around 4.2% in recent days.
However, after the CPI data, the 10-year yield broke higher, jumping 15 basis points to 4.32%.
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