CPI Inflation Comes In Hot, Keeping Fed On Guard; S&P 500 Steady

The CPI inflation rate unexpectedly fell in January, but the S&P 500 was little changed.

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May 14, 2023 • 4 min read

In January, the consumer price index was higher than anticipated. The annual CPI rate of inflation also dropped less than predicted. The core CPI rate, which excludes food and energy, was also higher than expected. After Monday's stock market rally, the S&P 500 fluctuated initially before closing with little change.

Wall Street expected 6.2%. The CPI inflation rate slowed to 6.4% in the month prior from 6.5%. The consumer price index increased 0.5% in the month. This was in line with expectations, but much more than the muted increases of only 0.1% and then 0.2% over the previous two months.

The core CPI increased 0.4% from December levels, exceeding the forecasted 0.3%. The core annual inflation rate eased from 5.7% to 5.6%, compared with 5.7% in the previous month and expectations of 5.5%. Core CPI inflation peaked in September at 6.6%, a record high for 40 years.

Jerome Powell, Fed chair, has stated that core nonhousing service expenditures are the most important for inflation forecasts. These data can be found in the Commerce Department’s personal income and spending data from the last month. Wall Street considers the CPI measure of services less rental of shelter to be a reasonable proxy for inflation, but there are serious flaws.

The CPI for January showed that services, excluding rent and shelter prices, rose 0.6% from the previous month. They also increased 7.2% compared to a year earlier. This is down from December's 7.5%.

The CPI report does not change the Fed's policy outlook. The Fed is erring on the side that monetary policy is too tight, so it seems almost certain to raise rates by a quarter-point in both March and May. The strong January jobs report, coupled with improved global economic growth, has put policymakers on alert against an increase in inflationary pressures. As recession looks less likely, more restrictive policies have a smaller downside.

The odds of the Fed raising rates a third time by July increased to 60% after the CPI data, from just under 50% before.

The Fed's future hikes will be determined less by the CPI and more by wage growth. Wage growth is the key indicator for the service sector inflation outlook. The current S&P 500 rally is a result of the good news that wage growth has shown a surprising slowdown.

The S&P 500 fluctuated after the CPI report. It ended up closing a little lower. S&P 500 rose 1.1% Monday, returning above the important 4100 level. The rally may have a limited upside in the near term. The retail sales report for Wednesday could fuel fears that the U.S. economic recovery is gaining momentum, requiring higher interest rates.

After the CPI data, the 10-year Treasury yield increased by 4 basis points. The 2-year Treasury rate, which is closely tied to Fed decisions rose 9 basis points to 4.62 %.

The S&P 500 closed Monday at a 15.7% gain over its closing low in the bear market, but it is still 13.7% lower than its closing high.

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After three consecutive months of declines, core goods prices increased by 0.1%. The 12-month inflation rate was now 1.4%.

Prices of energy rose by 2% in the last month, and by 8.7% compared to a year earlier.

Food prices at home increased by a moderate 0.4% in January, but they rose faster by 0.6% compared to December.

Used car prices fell 1.9% in the CPI report, whereas new vehicle prices increased 0.2%.

The price of apparel has risen by 0.8%, and is now 3.1% higher than a year earlier. Transport service prices increased by 0.9%. Prices for medical care services fell by 0.7% in a month. However, this was due to a large drop in the cost of health insurance. Prices for hospital services rose by 0.5% in the past month.

Powell has highlighted that it is possible to create an inflation index from the CPI which bears some relationship to the non-housing core services category.

Start with the services, minus rent and shelter. Subtract health insurance and energy services (which are derived from the profits of last year's insurer). Add lodging and food service. In January, prices for the CPI proxy of core nonhousing service rose by 0.5%, but the annualized rate of inflation over the past three months remained at 5.6%.

PCE Core Nonhousing Services covers 50% of household expenditure, whereas this CPI category only covers 29%. There are, in other words still large differences. The biggest difference is in health care, which accounts for almost 16% of PCE budgets, but medical services only account for less than 7%.

The CPI will not give you the best indication of PCE health service inflation, but rather Thursday's Producer Price Index. In a note published on Friday, economists at Deutsche Bank wrote that the PPI medical service component feeds directly into PCE. The news about health care inflation could be good, they said. The scaling back of the pandemic increase in Medicare physician fees, which began on Jan. 1, could lead to milder inflation after the big PCE price increases of January the past two year.