Heartache For the Fed

Shelter costs, which now make up more of the CPI than they did last year, remained elevated.

Detail of a fuel pump in a gas station
Diane Swonk

Diane Swonk

Chief Economist, KPMG US

+1 312-665-1000

The Bureau of Labor Statistics (BLS) revised the seasonal adjustment to the consumer price index (CPI) data for 2022 and the weights for the basket of goods in the index for 2023. The revisions boosted inflation measures in late 2022 and suppressed the rise in measured inflation in January 2023. The net effect was hotter, more persistent inflation than previously reported. In response, the Federal Reserve is expected to raise rates at least two more times in 2023 and hold rates high until early 2024. More rate hikes will be on the table as officials make new forecasts for the year at their March meeting.

The CPI rose 0.5% in January, five times the upwardly revised pace of December 2022. Prices at the gas pump and utility costs jumped. Food rose moderately on a month-to-month basis. Eggs surged 8.5% alone and jumped a whopping 70% from a year ago. The avian flu has culled the stock of chickens and constrained supplies of eggs. The CPI increased 6.4% from a year ago in January versus 6.5% in December.

The gains we saw on a year-over-year basis were especially notable given the surge we saw a year ago. That should have made for easier year-on-year comparisons. We are still at a rolling boil when it comes to inflation, which creates more heartache than love for the Federal Reserve.

The data for core (ex food and energy) CPI were not much better. The core CPI rose 0.4% in January, the same as December.  The core CPI increased 5.6% from a year ago, almost the same as the 5.7% pace of last month.

New vehicle prices continued to firm in January but the pace of increases is slowing. Affordability is waning. All-cash sales of new vehicles picked up as buyers attempted to circumvent higher financing costs. The ranks of those who can afford to cut a check that large are small.

Other goods prices accelerated during the month, despite an overhang of inventories. Everything from apparel to home furnishings and appliances increased in price during the month. Apparel prices were led by a 5.5% month-over-month jump in men’s underwear, pajamas and swimwear. I am guessing travel to warm resorts boosted those figures; that is as far as I want to go on that front.

Shelter costs, which now make up more of the CPI than they did last year, remained elevated. Home ownership and rents decelerated on the month, while hotel room rates picked up. Revenge travel remains strong; business travel is beginning to come back. A surge in convention business is filling the gap left by weddings that were delayed during the pandemic. If you haven’t booked summer travel, you might want to do so soon.

Core services inflation, which strips out shelter costs, rose 0.6% in January after surging 0.6% in December. Core services rose 7.2% from a year ago versus 7.4% in December. The Fed is watching this area closely as it tends to react more to tight labor conditions.

Historically, wage gains and core services inflation are tightly correlated. The only exception was the late 1990s boom when productivity growth was accelerating. That is not the case today, at least not yet. We need to see a much larger step up in investment and productivity growth for wage gains in the service sector to be sustained without losing ground to inflation. Firms, for their part, need to share productivity gains with workers for living standards to improve and income inequality to diminish.

Medical services fell 0.7% due to a quirk in the way medical insurance costs are measured in the CPI. Other measures of inflation show those costs rising in recent months. The outlier was nursing homes, which jumped 1.4% in price during the month. This is an area where staffing shortages are acute. Those costs do not reflect the backlogs to seeing doctors and routine exams, which are substantial.  


The Bottom Line:

Inflation remained searingly hot in January, which is bad news for consumers. The Fed has not yet beaten inflation. Brace for at least two more rate hikes. A one-half percent rate hike in March is on the table; more rate hikes are likely in the March projections from the Fed. 

More rate hikes are likely in the March projections from the Fed.