Name: Here’s What Stubborn Inflation in the January CPI Report Could Mean
Uploaded: 2024-02-13T15:35:00Z
Duration: 15 min 19 s
Description: Inflation defied economists’ expectations, holding above 3%. The latest data in the January CPI report are likely to have a big impact on the stock market and the Fed’s decisions on interest rates. WSJ’s Dion Rabouin explains where it all stands. Photo: Charly Triballeau/AFP/Getty Images

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Inflation defied economists’ expectations, holding above 3%. The latest data in the January CPI report are likely to have a big impact on the stock market and the Fed’s decisions on interest rates. WSJ’s Dion Rabouin explains where it all stands. Photo: Charly Triballeau/AFP/Getty Images

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Here’s What Stubborn Inflation in the January CPI Report Could Mean

Hey, out there. Welcome, welcome, welcome into Market Takes. I know you could have been anywhere in the world, but you're here with me. I appreciate that. I am Dion Rabouin reporter at the Wall Street Journal. Today we are breaking down the CPI report from January, the consumer price index. We got a report today. It's a little warm, it's not hot, it's a little warm. Expectation was for inflation to keep cooling. Well, inflation hasn't kept cooling. Inflation is a little warm. We're gonna talk about what that means a little. Oh, you touched this. Oh, all right. That's not what I was expecting. We're gonna talk about what that means, what it is, why it is, and how it affects the market. First, we're gonna talk about what the report showed and how that compared to expectations. We're gonna talk about some major takeaways from the report. I think there are quite a few and how that aligned with the inflation trends we've seen in recent months. We're gonna talk about the market reaction, I should say the market's reaction because stocks, bonds, currencies, commodities are all moving based on this report. And we are gonna talk through what that is. I'm gonna show you what we're seeing in the market. Talk about the big takeaways from this report and we will talk about what comes next, because we are always looking forward, even though it is backward looking data. So let's get into it. First of all, let's throw a chart up here on your screen, so you can see what I'm talking about. And what I'm looking at. This chart goes back to January, 2021. What you see here is a pretty clear trend. Inflation goes up, peaks in summer of 2022 and then comes down. Now what we have seen the past six months or so is inflation sort of moving toward the Fed's 2% target, right? Where the Fed wants inflation to be is right at that two line. And what we saw was it falling towards that and then picking up again and then coming down again. And what we're seeing now with inflation at 3.1% year over year for January, is that inflation looks to be plateauing potentially around 3% rather than 2%. And this matters because the Fed has said very clearly, we need inflation at 2%. We're not gonna entertain 3%, we're not talking about 2.5%. We need inflation sustainably down at 2% and with inflation holding steadily here around 3%, right? We're above 3% for the second month in a row, or sorry, above 3% continuing. Again, we were supposed to be getting below 3%. That's what economists had expected. Moving down into those two handled numbers, 2.9% is what economists had expected this report to show. But instead, we are above expectations again. Last month was 3.4%, now 3.1% and this chart just illustrates the way that inflation has not moved down towards 2%. It has managed to stay high. The other big issue here is what we see going on with core inflation. Now, headline inflation was. 3% month over month. That was higher than expected. A little higher actually than December. And we saw this a similar thing with core inflations. Let's put up a chart of core CPI, which strips out food and energy prices. That's holding steady around 4%. And what you see there is that plateauing trend is even more pronounced in the core CPI. So when you take out food and energy, which can move around significantly, in this report we saw energy way down, it's dragging that number lower. So when you take it out, what you see is inflation really straddling that 4% line. And core CPI matters because the Fed has said that that's a great measure of where inflation is heading. It's a great measure of the things that the Fed can control. The Fed really talks more about core inflation than they do about overall headline inflation. And what we see, and as you can see from this chart, core inflation is really holding right around 4%. And actually month over month, core inflation increased. It was about .4% this month after .3% last month. So we are seeing an increase or an acceleration of inflation, and that is exactly the opposite of what the Fed wants. And this chart really just illustrates, like I said, that CPI, that inflation is holding. It's not moving rapidly down, the way that we had seen in months before. That consistent lower pattern, which is what the Fed wants to see back towards 2%, it's holding it 3% on the headline and it's holding around 4% on core. And that could really throw a wrench in the works of what the market is expecting. Why we've seen so much bullishness in the market this year is because their expectations. Rates are pretty high now. They're the highest they've been in 22 years and markets are expecting for that to really just drop and for the Fed to cut rates pretty rapidly. Give the market some more bullishness, some more rocket fuel to move higher and inflation has to cooperate. And this report shows inflation is not cooperating. Housing was the main culprit. Housing or shelter inflation rose .6% month over month. But we also saw super core inflation. That's the term we haven't talked about in quite some time here on market takes. That services or core services minus housing that also picked up. So we're not seeing the things that the Fed wants to see, which is in turn what markets want to see, because markets want the fed to cut rates. The Fed has said, yeah, we're ready. We're locked and loaded. We're gonna cut rates, but we need to see some more data that shows inflation moving to 2%. This report did not do it. Gonna read you what I've heard from a couple analysts, a couple of economists, couple folks in the market, to give you an idea of how investors and how economists are viewing this report. Oh man, Brian Coulton, Fitch ratings Chief Economist said, "This is not a very good number. This is not a very good number. The headline rate stayed above 3% year over year, despite energy price declines getting deeper and core goods prices falling. The core CPI rate did not budge in year over year terms at 3.9% and the month over month rate picked up to .4%. Culprit with services, services prices grew by 0.7% month over month. The fastest pace since September of 2022." Why does September of 2022 matter? Again, let's go back to that chart we had up there earlier. September, 2022, inflation still was rising around seven, 8% on a year over year basis. Now we're getting down to around 3%, 4%, and we've got services price inflation, which is the big thing. We know goods prices are coming down, right? When you order a table, when you order, you know a car, things like that. When you're buying those goods, those prices have consistently been coming down, that slowing down and the services component, things that, you're going out to a restaurant, a bar, getting your hair cut, talking to your lawyer, those things, those prices are all rising. So this trend is suggesting inflation might get stuck and could even rise a little bit, which is not what the Fed wants. Let's talk about the major takeaways. Again, I wanna talk through what I'm hearing from analysts and what I'm hearing from economists. Wanna talk about my girl, Quincy Cosby, AKA, the Quincynator. She's the Chief Global strategist at LPL Financial. Sent me a an email this morning. Headline, "CPI is Still Too Hot for Fed Cuts to Begin." Much anticipated CPI report is a disappointment for those who expected inflation to edge lower, allowing the Fed to begin easing rates sooner than later. Quincy says across the board, numbers were hotter than expected, making certain that the Fed will need more data, before initiating a rate cutting cycle. And this is all about timing. Right now, I think folks are betting that the Fed is going to continue to cut rates because they've said that's what they want to do. That's where they, they don't wanna hold rates this high because it's constricting the economy, because it's making things harder for small businesses, for those smaller consumers. But inflation is still too high and they need to see evidence that it's coming down. This report does not do that. Quincy says the "Last mile as expected is proving to be stickier and more stubborn, inhibiting even the most dovish wing of the FOMC." For those of you not familiar with Fed speak, basically that means that this last mile of inflation, getting inflation to 2% from three or 4% where it is now, that's proving to be more difficult. Inflation is proving sicker. Staying at those levels proving even more difficult for some of the more dovish. Those folks who are more inclined to cut rates, who are more inclined to worry about what's happening with unemployment than they are to keeping rates high. The big question right now could be, does the Fed need to do more? Do they need to come out more hawkishly? Do they need to say, well, we might be thinking about raising rates soon. I don't know about actually raising rates, but if Fed Chair Powell comes out and says, that's what we're thinking about. If that statement at the next FOMC meeting says, we're thinking about maybe rates need to go higher, that could be big for markets and that could make a real difference in the bullish momentum that we have seen in markets. Last quote I wanna read from you is from my man, Ian Lyngen. He's the head of US rate strategy BMO capital markets. He put it very simply, he says, "Overall it was a decidedly stronger read on inflation that confirms well with Powell's unwillingness to discuss near term rate cuts." That's big. That says it all right there. Let's check out wsj.com, so you can see exactly what's going on in the markets right now. We see stock prices significantly down, especially on the Dow. The S&P 500 overall is showing stocks down by one about 1.4%, almost 1.5%. The market reacted very strongly in the future side as soon as this report was out. And we're seeing it right now. Very interesting that the NASDAQ is actually not lower. Is looking, moving back towards being positive. Usually the NASDAQ, those high flying tech stocks are the most vulnerable to these higher rates or the potential for higher rates from the Fed. But what we're seeing is, I think as those companies, as the NASDAQ is representing more big tech companies like Meta, like Apple, like Amazon, those companies, the market is expecting, hey, you know what? Even if rates have to stay high, those companies will be all right. Let's check out bonds really quickly. Show you what we're seeing in the treasury bond market. The 10 year note up about seven basis points. You see it happen right after this report comes out. This is about 8:00 AM right here. The market just jumps and you see a significant increase in the price of or in the treasury yields. That happened really across the board here, most significant here in the two and three year note, you see, boom, right there. Same thing. As soon as that report dropped 8:00 AM boom, treasury yields jump up. That means folks expecting higher inflation, higher growth, higher rates. And that's what you see there. That the two and the three year most correlated with what folks expect from the Fed. So this is showing folks do not expect the Fed to cut rates pretty immediately. And you see it across the board, you see it with the dollar. Boom, same thing. We even saw it a little bit with crypto prices. Look at Bitcoin and that move down lower, again, right around the time that this CPI report came out. And this really just illustrating that markets had a strong reaction to this number. This number really kind of throws off the theme that had been priced into markets for quite some time. And let's talk really quickly about the Fed. How does this influence them? Because they had come out saying, you heard it in the last FOMC report, if you were watching us here on market takes, I broke it down. The chairman was very clear. He said, we are ready to cut rates, just not yet. I think I compared it to a kid who wants to ride a rollercoaster. He sees it moving. He is like, "I wanna ride that," just not yet though. I need to see that it's safe. I need to see that no one's falling off, that no one's gonna fall off the track. That's what the chairman is saying. And this report is a little shaky. It's showing that maybe some folks were a little frazzled, maybe a screw or a nut or a bolt came off the rollercoaster. Now the kid's like, oh, hold on, hold on now I need to wait a little longer before I'm ready to get on that rollercoaster. The Fed has been clear that they are inclined to keep rates high, that they feel like they have time to kind of sit and watch. They don't wanna react too quickly and lower rates. They do want to do it. They are worried about the damage that this could do to the economy, but they don't wanna move too quickly. And this report seems to give them more evidence that they need to continue to wait longer. You see this in the Fed funds futures market. We had seen expectations coming into this year that the Fed would cut rates as soon as March. You really saw that really even into January ahead of the FOMC meeting. That's been wiped off the table after this CPI report. We are seeing expectations for a March rate cut down at about 8%. 92% probability in terms of what we're seeing from the Fed funds futures market that the Fed will not cut rates in March. And we are seeing expectations for overall rate cuts this year. Dropped to four. Now the market had been expecting six rate cuts coming into this year and in early and mid-January, that's been cut down to five. And now after this report cut down to four market pricing, in only four rate cuts. There's a very different market. If the Fed cuts rates four times versus six times, the Fed's summary of economic rejections suggested they want to cut rates three times. And again, the market said, ah, we don't believe you. We're not listening to you. You guys don't know what you're talking about. We could be seeing, again, the market's saying, all right, the fed's right, but now maybe the Fed needs to say, well wait a second, we release our next summary of economic projections at the March meeting. Maybe three rate cuts is too much. Maybe we only need to cut rates one time, maybe two times. And that could change things. So again, there's a lot about this report that doesn't just change markets today, it changes markets next week. It changes the expectations for what we could hear from the Federal Reserve at the FOMC meeting in March. A lot of things could change because of this one report. And again, it's all about inflation being sticky. Inflation holding about 3% on that headline level, holding about 4% on the core level, stripping out food and energy, that's big. Fed Chair Powell back in December, he said, "There's a lot of worry that inflation, that last mile could be really difficult, getting inflation back from 3% down to 2%." And we haven't seen a lot of evidence. Well, today we got some evidence, we got more evidence. And remember if you saw, if you were looking at those charts we showed at the beginning of the live stream here, it is looking like that last mile could be difficult. So listen, big picture. Fed may have more work to do in terms of talking to markets in terms of resetting expectations. That could mean that stock prices move lower, bond yields move back higher. That throws off the trend that we had seen. What comes next? Let's talk about that. Retail sales are out on Thursday, that's February 15th. You're gonna wanna watch those. If those again can confirm that folks keep spending, prices keep rising, you could have an extreme market reaction to that. PPI, the Producer Price Index that comes out on Friday. What are businesses paying. That has come down really significantly. We'll see if that trend continues. Last but not least, next week on Thursday, February 22nd, we have the existing home sales report will be right here on Market Takes breaking that down. And that report could be key, because the housing market is a big player in all this. It makes a huge difference in terms of what the Fed is thinking about the market and how it's thinking about the economy. And for more, check out my podcast WSJs "Take on the Week." We cut through the noise to explain the major business and financial news that move markets. Also, you can make smarter investing decisions, subscribe wherever you get your podcasts, Stitcher, Apple Podcasts, Spotify, I don't, whatever you kids are using these days to get your podcast. Check out WSJ's take on the week. That's gonna do it for me. I am Dion Rabouin reporter at the Wall Street Journal. Please come back and join us when we do it again next time.