What has happened recently?

(last month’s CPI, PPI and other reports)

CPI Data
In January, consumer prices increased by 0.3% monthly and 3.1% for the year ending in January, both
higher than expected. Core inflation—excluding food and energy costs—also increased more than
expected in January, gaining 0.4% and 3.9% for the month and year, respectively. To be honest, the
overall trend in inflation hasn’t changed much:

Source: BLS Feb 13 CPI Release

The index for shelter costs is much to blame. Shelter costs, which comprised 36.2% of the total
headline index, surged 0.6% for the month and 6.0% annually.
It is kind of weird how shelter costs are calculated and inputted into the CPI. Owner’s equivalent rent
alone made up over 26% of the index last month, and that’s only one component of total shelter costs.
OER increased 6.2% for the year, while actual rental costs increased by less (1.1%; Redfin).
Digging further, food prices continued to rise in January as well, gaining 0.4% for the month. But energy
costs brought the index down, as energy prices declined 0.9% in aggregate last month. Gas prices
declined 3.3%. The important thing to remember is that, broadly, inflation is still moving in the right
direction. We believe that the PCE report (out on the 29th Feb) would be something we should pay more
attention to, as that is the Fed’s preferred inflation measure.
As far as a “Soft landing” is concerned, Wages continue to outpace inflation, with real hourly earnings
(adjusted for inflation) increasing 0.3% monthly and 1.4% for the year. As long as wages continue to
outpace inflation thanks to a strong labor market, we’re still moving in the right direction (Probably the
labor market team could give more commentary on this).
PPI Data
On Friday, the BLS published the latest Producer Price Index (PPI) report, shedding some light on
wholesale inflation. PPI saw its largest jump since August last month, gaining 0.3% in January. This
came as a surprise as the producer prices declined 0.2% in December, just a month prior. Economists
had been expecting a 0.1% rise.
Core PPI also came in hotter than expected. Also expected to rise just 0.1%, core PPI jumped 0.5% in
January. When we take out transportation costs as well, we get the super-core PPI, which jumped a fat
0.6% for the month.
Extending our view to the past year, we can see that January’s jump might not be as scary as the monthly
figures imply. Headline PPI rose 0.9% annually, while core PPI leaped 2.6% over the same period.

Source: CME FedWatch Tool

This stickiness in inflation all but confirms inflation was, in fact, not transitory, as the Fed was saying
while stuck on repeat back in 2022. Supply chain issues persist globally, but the U.S. has been affected
less than other countries, at least so far.
JPow has been pretty clear in his message that the FOMC isn’t cutting anything until inflation is clearly
on its way out.
One inflation report showing the right numbers likely won’t be enough to move the needle, which could
be why markets have pushed back their due date from March to June already. Further delays in cutting
could be on the horizon as well. Again, Next Friday’s PCE report would be important.

Housing Data (For Saatvik)

On February 14th, we got the latest update on mortgage rates in America. Standard 30-year fixed
mortgage rates increased from 6.80% to 6.87%, per the latest weekly data from the Mortgage Bankers
Association. We’re quite far from the 8% level we saw last year, but we’re still moving in the wrong
direction.
Buyers are pulling back!
First and foremost, housing supply remains the key driver. Chronic underbuilding over the last decade
has created a shortage so extreme that home prices could barely fall even despite massive interest rate
hikes. So far, high home prices have been sticky, causing builders to start, well, building more homes.
But, although the increase in inventory and volatility among rates have started to unfreeze the housing
market, sales levels are still far below the historical norm. One interesting thing in the data is that the
percentage of homes in the total housing inventory considered “new construction” is close to reaching
record highs. So, even with more and more existing homes coming on the market, it’s clear that demand
is focused on new homes.
This preference for new homes can have two impacts: Increase the time it takes for the supply to catch
up to the demand (you have to “build” the new homes) and increase the average price tag of homes
(new homes will obviously be sold at a premium).
Maybe this could explain why we’ve started to see another rise in home prices over the past 9 months
even though rates have continued to increase in that time. You kind of have a coincidence of four
factors: High demand, less supply, more new homes, higher rates.
Retail Sales
The January retail sales report was released on February 15th. Spending plummeted more than
expected in January, falling 0.8% for the month.

Census Bureau
Both December and November total sales figures were revised lower as well. November was nearly flat,
while the holiday season still saw a 0.4% jump.
Consumer spending in the U.S. is undoubtedly slowing down. For inflation, this could be a good thing.
Less spending = less demand for goods = less price increases.
 CONSENSUS (& OUR) EXPECTATIONS
The broad consensus for this year is that inflation will remain sticky and it will take some time for it to
come down to the Fed’s 2% target.
Consumer expectations for inflation 1 and 5 years out from now were entirely unchanged at 3.0% and
2.5%. The FOMC needs to be careful and make sure it doesn’t end up being too restrictive and
overshoots the 2% target.
On inflation, we expect to see continued progress over the coming quarters. Supply chains are
continuing to heal and price pressures from shelter and services continue to moderate. Notably,
services demand should cool as consumer spending wanes, but upward wage pressures may persist.
For context, services inflation is what’s been keeping inflation this high compared to goods inflation.
Another interesting thing to note, the stocky inflation came in at 4.6% and the flexible inflation came in
at -0.9%. So, it’s clear that it’s just a matter of time before we actually start seeing cooling inflation data
and subsequent rate cuts.
We agree with the consensus that there would be 3 rate cuts this year. As far the timing is concerned,
we believe the first rate would be either in the July meeting or the September meeting, with the fed
cutting rates by 25 bps every subsequent meeting. Given the JPow’s stubbornness and the data coming
in, June 2024 feels a little early for the first rate cut. However, that could all change with the PCE data
coming out next Thursday.
For Canada, the CPI came in at 2.9% when the expectations were 3.2%. So, we’re moving on the right
track here and we believe that we will start seeing rate cuts soon enough. Consumer demand has
continued to soften on a per-capita basis and if you take out the mortgage interest rates of the picture,
the price growth would be in the 1-3% target range set by Bank of Canada.