Weekly Market Perspectives: Inflation stings consumers with Fed likely to hold

Published: March 18, 2024

Coming off a week when investors expressed optimism that a normalizing labor market should give the Federal Reserve more room to cut rates, price stability (i.e., inflation)—the other half of the dual mandate—proves stubborn. The recent CPI and PPI readings throw into question Powell’s (and other Fed members’) confidence that inflation is getting closer to the 2% target. While inflation proves persistent, retail sales came in lower-than-expected, indicating a slowdown in consumer spending in 2024. Investors continue to grapple with each new piece of information that could sway the timing of the Fed’s first rate cut, although the recent price reports suggest there won’t be any policy changes at upcoming meetings in April or May. Markets traded lower following the inflation prints—the S&P 500 Index ended the week down 0.1%, while the US Aggregate Bond Index finished lower by 1.2% as investors pushed yields materially higher in anticipation of tighter monetary policy.
According to Tuesday’s Bureau of Labor Statistics (BLS) report, consumer price increases topped forecasts again in February, particularly for shelter, transportation services, and clothing. Headline CPI jumped 0.4% from the prior month, while the core measure, which excludes food and energy, came in above expectations at 0.4%. Headline CPI increased 3.2% year-over-year and the core measure was higher by 3.8%, both of which were above consensus. Shelter prices—the largest category within services—climbed 0.4% in February, slowing down from a big jump in January, but still contributing over 30% to the month-over-month increase. Following a brisk January report, the February figures are unlikely to give the Fed confidence that inflation is coming down smoothly to the 2% target and adds evidence that economic conditions are re-accelerating. While optimism surrounding the US economy has improved, many Americans are still feeling the hangover effects of price increases that have created additional financial hardship, adding an interesting dynamic for investors to watch, particularly in an election year.

Consumer Prices Have Risen 21% Since 2020
CPI: Cumulative Price Gains (%)

Source: Bloomberg, Bureau of Labor Statistics

Substantiating the CPI report, the BLS report showed that producer prices (PPI) rose in February by the most in six months, pushed higher by volatile food and energy costs. PPI increased 0.6% from January and the core measure pushed higher by 0.3%, both coming in above expectations. Although PPI tends to be more volatile than CPI, the gauge can be used as a leading indicator for input costs for final consumer prices as well as an input into the Fed’s preferred inflation measure—the personal consumption expenditures gauge (or PCE). The recent trend for both CPI and PPI is likely concerning for the Fed, given the absence of other major data releases before the next Fed meeting. These hot readings will likely reinforce the wait-and-see approach many Federal Reserve Governors have been communicating.

US Consumer, Producer Prices Accelerate at Start of 2024
CPI vs PPI (MoM%)

Source: Bureau of Labor Statistics

Retail sales figures published from the US Census Bureau Thursday showed weak growth for the second straight month following a robust holiday period. Month-over-month retail sales came in at 0.6%, while the control group, a key input into GDP calculations, was flat. Both key measures missed expectations by some margin. Excluding noisy auto and gasoline expenses, sales increased 0.3%, effectively in line with forecasts. Of note, this release also included a significant downward revision for January figures. While January is usually a time for a seasonal reset, the second straight weak report casts doubt on the consumer’s ability to keep spending. After years of price increases and higher financing costs, recent data points to a consumer buckling to greater cost pressures, even as the economy posts resilient growth. Delinquency rates on credit cards and auto loans just hit the highest levels in more than a decade and, for the first time on record, interest payments on non-mortgage related debts are the same as mortgage interest payments. The elevated borrowing costs are stinging any consumer who did not lock in record-low long-term rates. With the Fed set to hold rates next week, there is little reprieve in sight.

Interest Payments by US Households
Mortgage vs Non-Mortgage (SA)

Source: Bloomberg, Bureau of Economic Analysis

Even as interest costs take up more business and consumer income, money market assets continue to post new all-time highs. With rates sitting above 5%, interest income from money market assets is helping to offset costs elsewhere, but this is only benefitting the upper quartiles of consumers with cash saved. Furthermore, research suggests that cash assets sit at normal levels as a percentage of the full balance sheet, whereas financial assets are pushing to multi-decade highs, helping the wealth effect – or when consumers are more willing to spend from feeling wealthy. Again, the top quartiles are asymmetrically benefitting from rising asset values as the lower quartiles continuously report financial stress from rising prices.

Household Balance Sheets: Cash Assets vs Equities (% of Total)

Source: Bloomberg, Federal Reserve

– Written by Eric Schmitz, CFA