US CPI Review: January 2024 (with flash February CPI estimates)

While adjusted core services prices saw another month of elevated growth, the broader disinflationary trend remains intact - particularly for the PCEPI, which is less exposed to lagging rents.

Headline inflation falls to 3.1% YoY

Headline CPI inflation moderated to 3.1% YoY in January, down from 3.4% in December. This marked the lowest rate of headline CPI inflation since June.

Core CPI ekes out a 10th consecutive month of disinflation

While remaining at 3.9% YoY, core CPI inflation managed to eke out a tenth consecutive month of disinflation on a two decimal place basis, with growth falling to 3.86%, from 3.93% in December.

Spot market rent adjusted CPI growth remains below 2% YoY

On a spot market rent adjusted basis, headline CPI growth fell to 1.4%, down from 1.6% in December — this marks the eighth consecutive month of YoY growth being below 2%.

Core CPI growth remained stable at 1.8% YoY — this marks the sixth consecutive month of YoY growth below 2%.

Growth above my forecast and consensus — potentially reflects elevated new year seasonality

In comparison to not only my forecasts, but the consensus estimates, CPI growth was notably higher than expected, which explains the significant declines seen in both equity and bond markets in response to the latest inflation data.

The relatively larger than usual variance to my forecast was driven by higher than expected other durables price growth, the spike in OER, higher than expected airline fares, and the volatile energy services component.

Note that CPI growth notably surprised on the upside in January 2023 as well, suggesting that new year price changes may have seen more seasonality than usual, over the past two years.

Services price growth remains elevated, but the disinflationary cycle continues

Despite the sharp market reaction to the latest CPI data, there’s no need for alarm — the data does not point to a second wave of inflation and the disinflationary cycle is continuing.

While adjusted core services price growth remains elevated, as opposed to accelerating, relative MoM growth for January was around the midpoint of the range seen during 2023.

On a 3-month moving average basis, relative price growth is slightly below the average rate that’s been recorded since January 2023.

While clear services price disinflation is thus yet to be seen, as opposed to seeing a further significant increase in growth, it remains consistent with levels seen during 2023.

Meanwhile, growth in the M2 money supply remains constrained by the Fed’s significant interest rate hikes and QT, which continues to lead to significant durables price deflation.

In order for the disinflationary cycle to be marked as ended, and for concerns about a potential second wave of inflation to begin, both of these items would need to see a material resurgence in growth.

The reason for this, is that prices follow changes in the money supply, and durables prices tend to be the most response to significant changes in M2. Services prices are instead a lagging indicator, whose price changes follow prior changes in M2 and durables/nondurables prices.

Main implication of increasingly lagging services price growth is that the Fed is likely to remain tighter for longer — but remember, PCE inflation is materially below the CPI

As opposed to a renewed wave of inflation, the main implication of increasingly lagging services price growth, is that Fed policy is likely to remain tighter for longer, with the latest CPI data raising the odds that the first interest rate cut is pushed back to June.

Any expectations that QT will be wound down in the near future should prove to be particularly premature, as barring a recession, significant sums in the Fed’s RRP facility suggest that whether tapered or not, QT can likely continue until at least the end of 2024 — for more information on the impact of the Fed’s RRP facility on the wider economy, see my recent research report on the latest Treasury refunding annoucement.

Despite another month of materially elevated services price growth in the latest CPI data, it’s important to remember that the Fed’s preferred inflation measure, being the PCE Price Index (PCEPI), is recording materially lower growth than the CPI, and that this is likely to remain the case over the months ahead — the key reason for this, is the lower weighting to lagging shelter components in the PCEPI.

With current 6-month annualised core PCE growth just 1.9%, a return to the Fed’s 2% target is in sight of being achieved, which is likely to keep an easing bias in focus.

Flash CPI estimates for February: headline 3.2%, core 3.6%

Following adjustments made to my CPI model in light of the latest CPI data, my current provisional CPI estimates for February, are for headline CPI inflation to rise to 3.2% YoY, and for core CPI inflation to fall to 3.6%.

The estimated divergent moves between the headline and core CPI in February, reflects the recent rise in both wholesale and retail gasoline prices, which flows through to a currently significant estimated increase in the CPI energy commodities index.

On a spot market rent adjusted basis, I expect headline CPI growth to rise slightly to 1.5% and core CPI growth to fall to 1.6%.

These provisional estimates are scheduled to be finalised in the next instalment of my US CPI Preview, which will be released prior to February’s US CPI report.

Breaking down the details

Used car prices plunge, while new car prices continue to disinflate

In my latest US CPI Preview, I highlighted that a large gap had opened up between retail and wholesale used car prices, which pointed to significant downward price pressure on retail used car prices over the months ahead. This led to an expectation that used car prices would see a major MoM decline in January.

A major MoM decline is what occurred, with used car prices falling by 3.7% MoM. Despite this large decline, a significant gap remains between wholesale and retail used car prices, pointing to further downward pressure on retail prices over the months ahead.

While recording MoM growth for the first time since September, the MoM change in CPI new vehicle prices was below its historical average for a fourth consecutive month, which saw YoY growth moderate to just 0.7%.

Other durables prices rise, but this comes after four large MoM declines

Other durables prices recorded a large spike in MoM growth, with prices rising by 0.9% in January. This was the largest relative MoM increase since August 2022.

While this is a large increase, given that it follows four consecutive months of materially below average MoM growth, the broader price trend remains weak, with the 3-month moving average of relative price growth still firmly negative. Nevertheless, the large MoM increase in January means that February’s MoM price growth will warrant close attention.

While lagging rent based components show mixed shifts in January, ignore the noise — underlying spot market rents reveal the broader direction

For a second consecutive month, rent of primary residence (RPR) saw MoM growth that was 0.12% above its 2010-19 average, which saw relative MoM growth fall to its lowest level since December 2021 on a 3-month moving average basis.

Though moving in the other direction was owners’ equivalent rent (OER), which saw MoM growth that was 0.34% above its 2010-19 average for January, which was the largest relative increase seen since May. On a 3-month moving average basis, relative MoM growth rose to the highest level since July.

As OER removes the value of any utilities that might be included in a rental sample, RPR and OER do see MoM differences, though given that the primary component of both of these indexes is measuring the same thing (being rents), the two indexes generally move in a similar pattern over time.

Given that underlying spot market rental growth continues to remain relatively low, I continue to expect both OER and RPR to moderate gradually over the course of 2024.

As this moderation is expected to only be gradual, the lower weighting to lagging shelter components in the PCEPI, is likely to see headline/core PCE inflation remain below headline/core CPI growth over the months ahead.

Motor vehicle maintenance sees a MoM spike, motor vehicle insurance remains elevated

After recording four consecutive months of below average or relatively moderate MoM growth, the CPI motor vehicle maintenance and repair category saw MoM growth spike in January.

After looking as if motor vehicle maintenance and repair costs had established a clear disinflationary trend, January’s data means that this assumption no longer applies, with February’s data now holding outsized importance.

Once again, CPI motor vehicle insurance prices recorded very strong growth, with a new cycle peak for YoY growth recorded — 20.6% in January. This remains a key driver of elevated CPI services price growth.

Hospital and related services prices continue to rise

In addition to the CPI motor vehicle insurance category, the CPI hospital and related services component is the other key CPI item that continues to record persistently above average growth.

January was no exception, with MoM growth 0.7% above the 2010-19 average. This saw YoY growth rise to 7.8% YoY, with potential further material increases to come in February and March, as relatively low prior comparables are cycled.

Internet services prices also see a MoM spike

In a similar frame to the CPI motor vehicle maintenance and repairs category, CPI internet services price growth spiked in January, after previously seeing four consecutive months of below average, or relatively modest MoM growth.

As is the case with the CPI motor vehicle maintenance and repairs component, this now raises doubts about how enduring the disinflationary signs of the past four months are likely to be. Again, February’s data will be an important indicator in helping to answer this question.

Airfares move higher despite falling jet fuel prices

A notable driver of the divergence between the actual CPI numbers and my forecasts in January, was the volatile CPI airline fares component, which despite three consecutive months of falling jet fuel prices across October to December, recorded a relatively large MoM increase in January.

Recreation services and other personal services price volatility continues

Speaking of volatile CPI categories, once again, the CPI recreation services and CPI other personal services components saw a flip in relative MoM price growth.

After recording very high MoM growth in December, the CPI recreation services component saw MoM growth that was in-line with its historical average in January. This continues a period of sporadic price growth, with MoM price growth either below, or in-line with its historical average in four of the past six months, but way above the historical average in the other two.

Meanwhile, after recording relatively modest MoM price growth for three consecutive months, the CPI other personal services component recorded relatively high MoM growth in January.

As I have written about for sometime now, while the consistent recording of below/relatively modest MoM growth in these two CPI components shows some disinflationary signs, given that such growth continues to be intermingled with the odd month of very high relative MoM growth, the broader price trend continues to show neither a clear acceleration or deceleration.

While I expect ongoing relative pressure in the M2 money supply to eventually lead to disinflation in both of these items, current trends suggest that a clear disinflationary trend may be many more months away.

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