Consumer Price Index and Producer Price Index Show Mixed Signals on Inflation
Last week brought several economic data releases that showed conflicting signals about inflation and economic growth, which could support different perspectives on whether the Fed should cut rates soon or hold them steady.
The Consumer Price Index (CPI) rose on a monthly basis and declined only slightly year-over-year.
However, when excluding volatile food and energy prices (Core CPI), the monthly increase was more significant, and the annual inflation rate remained nearly twice the Fed’s 2% target.
While the overall downward trend in inflation is still encouraging, declines have disproportionately come from goods prices, while services inflation remains strong.
At the last Federal Open Market Committee (FOMC) meeting, Fed Chair Powell noted they want to see more sustainable declines across categories, signaling they are looking for broader-based improvement, and not just in goods.
To give credence to this point of view, the Producer Price Index (PPI) showed a monthly increase and was flat annually.
Like with CPI, when we take out the more volatile food and energy sectors (core PPI), the monthly gain is even more pronounced and the annual number shows an upward movement.
Mirroring CPI, the services component of PPI showed the strongest gains at 2.2% annually. With PPI rising, it’s possible CPI gains could follow, arguing against near-term rate cuts.
Declines in Retail Sales Could Support Case for Earlier Rate Cuts
Conversely, retail sales declined in January on both a headline and inflation-adjusted basis, signaling potential economic weakness that could warrant earlier rate cuts.
With the decline in headline and inflation-adjusted numbers, we could see a weakening of the strong economic growth we saw in 2023.
Early February data also showed continued contraction in manufacturing activity. Both the ISM Manufacturing Index and industrial production remain down, alongside lower capacity utilization.
The fall in capacity utilization indicates that when activity picks up in manufacturing, capital expenditures will be muted as excess capacity is used up first.
Finally, a reversal in recent gains with a monthly drop to 1.46MM in housing starts also signals economic headwinds.
Outlook
Overall, calls for imminent rate cuts seem premature given stubborn inflation in services. It appears the Fed will want to see a downward trend for inflation in services before cutting rates. The Fed’s caution is warranted as it appears they want to avoid the mistake of the 1970s, in which inflation was seeming entrenched as the Fed loosened rates too soon. However, as the decline in retail sales shows, the Fed may not be able to engineer a so-called soft landing and a shallow recession is still a distinct possibility.
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