The CPI report for January was released this morning, and as I listened to the commentary that followed the release, my mind turned to the Simon and Garfunkel song “The Boxer,” where Paul Simon wrote “a man hears what he wants to hear and disregards the rest.” Talking heads on business TV usually feel that they must feature commentary on major data points from both sides of the political divide. That sounds reasonable, but the resulting bickering and spin often make people perceive a factual report as something that is purely a matter of opinion. They then distrust the numbers and look at things as a commentary on the political situation, with some inherent bias.
So, when somebody from the Right tells you that this report was a disaster and that we are headed for a disastrous recession at the same time as somebody from the Left says that it is nothing to worry about and is really a sign of a strong economy, it is important to understand that neither statement is a true representation. It is all just noise.
In fact, the CPI report was neither tragic nor irrelevant. The January numbers were worse than anticipated and not a great sign in terms of what they mean for the Fed’s actions. However, there are logical reasons why we saw these numbers, and the idea of an early rate cut this year was always the product of an overly optimistic stock market, and never something that the Fed seriously considered. Moreover, nobody who understands the nature of CPI, including the FOMC members, will make any decision based on one single report.
The chart below, lifted from a CNBC report, demonstrates why they shouldn’t:
After showing a monthly gain of 1.2% in June of 2022, the CPI index was basically flat for July and showed only a 0.2% increase in August of that year. Did that mean that inflation had been beaten? Of course not. Nor was the increase in the index from May to August last year an indication that inflation was roaring again. From a policy perspective, what matters is the trend of the index, not one month's read. On that basis, nothing really changed this morning.
Inflation is a lot tamer than it was at its 2022 peak but is staying stubbornly above the Fed’s 2% target rate. That has been the case for well over a year now and is why the Fed has been cautious about the possibility of rate cuts anytime soon but still optimistic that, given time, their target can be reached. Once again, nothing has changed.
If you dig a little deeper into the numbers, the relatively high print for CPI is really the product of one thing. The largest contributor to the increase by far was shelter, which rose 0.6% as compared to the previous month and accounted for around two thirds of the overall increase. The shelter component of CPI is considered by most people to be the least reliable of all as a guide to overall inflation in the economy and has been distorted by the policies designed to fight rising prices elsewhere. Higher interest rates should discourage property buyers, which pushes prices down, but they also discourage anyone from moving, which pushes prices up.
In other words, if you have a mortgage rate of about 3% on your home, moving means closing that mortgage out and taking out another mortgage at around 7%. You either pay a lot more per month or downsize. For most people, just staying put is a better option. That limits supply, and it seems to be doing so more than higher rates are limiting demand. The result is a tight market, higher house prices, higher rents, and therefore an exaggerated shelter cost number. And, of course, higher mortgage costs for those who do move also contribute to that.
From the Fed’s perspective though, what matters is that when you strip out housing and the notoriously unreliable food and energy numbers, underlying inflation in the U.S., while not at ideal levels, is at least under control. The obvious conclusion there is that “higher for longer” is still the way forward, and that a soft landing is still distinctly possible. For investors, that means ignoring the attempt to politicize this and continuing to stay invested, but with a somewhat cautious approach.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
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Martin Tillier
Martin Tillier spent years working in the Foreign Exchange market, which required an in-depth understanding of both the world’s markets and psychology and techniques of traders. In 2002, Martin left the markets, moved to the U.S., and opened a successful wine store, but the lure of the financial world proved too strong, leading Martin to join a major firm as financial advisor.
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