Inflation Argues For Fed Hikes, But Bank Turmoil Eyed

Core inflation in the US rose slightly more than expected last month from January, data out Tuesday showed.

Consistent with a number of sell-side predictions+, the MoM core reading rounded up to 0.5%, but it was close. Unrounded, the monthly advance was 0.452%.

That kind of nuance does matter currently, or at least it might’ve mattered were it not for the bank failures, which relegated everything else, inflation included, to second fiddle this week.

The headline gauge matched consensus, rising 0.4% from January (less than that, unrounded).

Not surprisingly, shelter was the largest contributor, accounting for nearly three-quarters of the all-items increase.

The food at home gauge rose 0.3% MoM. That was the smallest monthly advance in quite a while, and the YoY reading is close to falling back into the single-digits. Overall, the food gauge rose 9.5% from the same period a year ago.

Energy prices receded from January, and the gasoline index fell 2% measured against February of last year. Natural gas prices posted a very large monthly decline. 12-month price growth on the electricity gauge continues to loiter squarely in the double-digits.

Notably, used vehicle prices moderated further, falling 2.8% from January and nearly 14% from February of 2022. Recent gains+ on the Manheim index (in January and February) may show up on a lag starting with this month’s figures (i.e., March CPI released in April).

For now, at least, used vehicles are still providing the Fed with a disinflationary tailwind.

Elsewhere in the report, apparel prices rose 0.8% for a second month (unwelcome at the margins), transportation services posted the largest monthly increase since September and the services less energy category posted another sizable monthly gain.

The shelter and rent gauges are obviously still very elevated. The overall shelter index rose 0.8% MoM in February, quicker than January’s 0.7% pace. OER posted a second consecutive 0.7% monthly gain, and the 8% YoY increase is sky-high.

Eventually, these measures will come down on a lag. Or so we’ve all been promised.

Most importantly (and I’ve buried the lede, as is my wont) core services ex-shelter rose 0.43%, up from 0.27% in January, while core services ex-rent/OER rose 0.51% versus January’s 0.36%. Those are proxies for the aggregate that’s pivotal for Fed policy, and those readings don’t argue for complacency.

And yet, to state the obvious, next week’s FOMC decision hinges on developments in the banking sector, not Tuesday’s inflation data. Some readers probably won’t be enamored with that assessment, but it is what it is.

“We don’t see the need to hike rates. The tightening of lending conditions that will inevitably result from the fallout of the past few days heightens the risk of a hard economic landing and inflation returning to target by early next year,” ING’s James Knightley said, adding that even so, he does believe there’s “an inclination for the Fed to hike if conditions allow.”

February’s inflation report plainly made the case for another 25bps hike in a vacuum. All else isn’t equal here, though. Had the US not experienced the second- and third-largest bank failures in American history over the past several days, some observers would be making the case for 50bps today, citing Powell’s remarks to the Senate last week (even as he tried to walk them back the next day). But those banks failed. This is a different world versus a week ago.

To reiterate, there’s no chance now of a 50bps hike next week, and frankly, the absence of a big upside surprise from February’s CPI report will probably give the Fed cover for a pause if that’s their inclination (and I’m not saying it is). Sure, the trend in underlying services inflation is worrying, but nobody outside of macro and market circles will be parsing that nuance today, even as Main Street feels that nuance every day.

So, from the perspective of the general public, today’s CPI report showed that inflation in America remains far too high — nothing more, nothing less. And, under the circumstances, that gives the Fed a little breathing room, I’d argue, as it means Powell won’t be burdened by a big upside CPI print (i.e., a “surprise” beat) if he ends up having to explain a dovish turn.

Journalists will ask Powell questions next week about the underlying trend in services ex-housing prices, but the public won’t be listening to the press conference, and even if they read an account of it after the fact, they’ll be reading for soundbites about bank failures and their deposits which, the government insists, are safe.


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10 thoughts on “Inflation Argues For Fed Hikes, But Bank Turmoil Eyed

  1. Hey kids! Let’s play a word substitution game!
    “‘It became necessary to destroy the town to save it” a United States major said in 1968.
    Can you change the sentence so you can use “the economy” and “a Fed governor” ?

    1. I read all your comments with interest but, with respect, what should we be doing and who should be doing it? Do we just let everyone go on with no proper response and let all the folks who make bad decisions just fail. Seems like that’s just another way of saying let’s burn a bunch of houses down and let people die to save …. what? We had an unexpected pandemic which nearly destroyed the country and killed more than a million people. We responded to that to minimize the economic damage. What would have happened if we hadn’t done that? We let our leaders decide … remember Congress authorized all of this. Ok, so the collateral damage was inflation which we now have to fix to keep our assets from losing most of their value so we can end up just like Turkey. Turning a ship is hard, especially one with 335,000,000 people on it. If you had been asked to bet everything you own on the idea that all the events past 2019 happen just as they did, you would probably have lost it all. No one saw all this. But what did happen was messy and we didn’t lose it all, at least I didn’t. There are 8 bil people in the world living in ~200 sovereign nations, all with different cultures, needs, ideas, resources, problems, etc. We can’t even accept the nature of our own country or the facts of our existence. So what’s best for everybody? I sure don’t know and I doubt anyone else does. Like the man said,”Everybody’s got a plan until they get hit hard in the face.”

      1. LuckyOne – That was over the top, no doubt. I have no quarrel with responses to the Covid crisis.

        But just what has raising interest rates achieved? Especially for main street, which Powell and company professed to be protecting?

        Housing affordability is worse than before, as are new car prices thanks to higher financing rates. Nor have food, energy and healthcare prices been tamed by higher rates.

        The Fed had to move, at first. But seeing this outcome, why do Wall Street and academics keep calling for more leeches to be applied?

        Now, what do I suggest be done instead? Uh, well, maybe, err….

        1. The Fed’s rate hikes have not had the size and speed of effect that many were hoping or expecting.

          I think that reflects the power of the underlying inflationary forces.

          That’s not just on Main St but also on Wall St. If you’d told me in late 2021 “psst, the Fed will raise rates 425 bp in a year, S&P500 forward earnings will fall every quarter, a major land war will erupt in Europe, and mega-tech will go ex-growth” and asked me to guess the S&P500 multiple and price in spring 2023, I wouldn’t have guessed 17X and 3900. I also wouldn’t have guessed UE at 3.6%, 10MM open jobs going begging, or house prices up +8%.

          In hindsight, maybe one can say the Fed should have hiked by 600-700 bp by now. Or maybe in early 2021, when UE was still > 6%, dying people still laying in hospital corridors, and the rest of us scrambling for vaccinations. Or maybe 425 bp by now will turn to be right, and it just takes that long for rates to transmit effect.

          I don’t think we can say that the Fed should not have raised rates and/or should be doing something other than raising rates, because that is all the Fed can do.

          Powell has a big stick, but only one stick. His choice is to hit with the stick or give up. I don’t think he’s going to give up.

        2. I count myself among the mythical main streeters. I’m tickled that interest rates are elevated and, hopefully, going higher. So, it gores someone’s ox. Our financial profile improves with higher rates.

  2. Curious what people think of the merits of a 25 bp hike to not only stay the course re inflation, but possibly also signal liquidity concerns are contained (even if they are not). Pausing altogether, even if resumed at the May meeting, feels more panicky to me than not pausing. Would a 25 bp hike materially worsen liquidity concerns? I say no. Psychology is my major concern right now.

    1. that’s my 3 cents take … 25bps would express confidence that current banking challenges are contained (like you just said) while also keeping potential financial loosening animal spirits at bay…

  3. On a side note, does anyone have some color or nuance as to why bitcoin has been soaring since this started? I mean, is this our flight to safety?! When I read about Circle and other alt/stable coins having money in these regional banks, I figured it would be net negative for crypto, but bitcoin and ether soared even before they announced the bailout facility.
    I feel like I’m being played here, if the government soon announces a digital currency, it all might make sense. Raise rates at record speed, let the banks start to fail(oops), announce a nice “safe” digital currency backed by the government.
    Sorry for the conspiracy theory, next thing you know I’ll be thinking they knew about Pearl Harbor.
    Apparently Frontline is airing “age of money” tonight on PBS

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