Inflation Data Clouded by BLS errors, Future Rate Cuts Likely Despite Risks
Inflation markets have remained relatively stable over the past month. The apparent increase in short-term inflation expectations is largely attributed to a quirk in the calculation of one-year swaps, rather than a genuine rise in expectations.
Economists anticipated a +0.31% increase in the seasonally adjusted headline CPI and +0.32% for Core CPI in December. If taken at face value,the actual figures of +0.307% and +0.239% respectively would annualize to 2.9% for Core CPI and 3.75% for headline CPI,though analysts caution against annualizing a single month’s change.
The Median CPI is expected to show a “snap-back” effect, likely falling between 0.30-0.35%, depending on seasonal adjustments applied by the Cleveland federal Reserve. While September’s OER number was an outlier, the last truly normal data point was in August.
Core goods prices are currently up +1.42% year-over-year and appear to be leveling off, potentially due to the waning impact of tariffs and softer Used Cars data. Core Services, heavily influenced by housing, continue to decelerate, but the caveats surrounding rent data remain notable.
Rents have largely returned to previous trends, with Primary Rents increasing +0.26% month-over-month and OER rising +0.31% month-over-month. This suggests the September dip in OER was temporary, and rents are still running at 3-4% annually. A recent report by Barclays, titled “Apples and oranges in the CPI basket: Why market rent gauges mislead on shelter,” highlights the discrepancies between continuing rents (90% of the market) and new rent indicators.
To address these issues, one analyst migrated their rent model to focus on landlord costs, which currently indicate rents should remain around 3%, making a sharp decline unlikely. This suggests that achieving a 2% CPI target will require a significant drop in goods or core services prices,which is not currently anticipated.
Core services ex-rents, or “Supercore,” are showing signs of improvement, partially due to a -1.1% decline in Health insurance. Though, the overall picture remains complex. The Enduring Investments Inflation Diffusion index indicates a slight upward trend in price accelerations and decelerations.
Ultimately, inflation is likely to settle in the mid-to-high 3% range.The tailwinds that drove inflation down have largely dissipated, necessitating tighter monetary policy. Though, the Federal Reserve appears hesitant to adopt a more hawkish stance, with new board members leaning towards dovish policies. Furthermore, potential government actions, such as convincing Fannie Mae and Freddie Mac to purchase $200 billion in mortgages, could inject further liquidity into the market. “A Federal Reserve which appreciated the inflation risks would be preparing to drain away that liquidity, no matter what it was going to do on interest rates,” the source noted, adding that there is currently no indication of such action.
as an inevitable result, dovish outcomes from the fed are increasingly probable, even if Chairman Powell attempts to navigate political pressures. This suggests a risk of continued loose monetary policy and potentially higher inflation, though not to the levels seen in 2022. Getting the direction of inflation right will be crucial.
