CPI: Fed to remain patient as real wages rise 1.4%

REAL ECONOMY BLOG | February 13, 2024

Authored by RSM US LLP

Energy and goods disinflation continue to underscore slower growth in the U.S. Consumer Price index, which increased by 0.3% on the month and by 3.1% on an annual basis, according to Labor Department data released on Tuesday.

Disinflation in the energy and the goods sectors has now resulted in a 1.4% annual increase in real average hourly earnings, which will bolster overall spending.

When taken as a whole, January’s data shows that inflation is continuing to ease even as wages increase on an inflation-adjusted basis—an undeniably positive development.

But sticky and stubborn inflation inside the housing complex implies that expectations of a rate cut by the Federal Reserve need to be pushed back to midyear and not in March as some have expected.

This shift in outlook is clearly behind the rise in the 10-year Treasury yield and is in line with RSM’s year-end forecast of 4.2%.

Once one strips out the more volatile food and energy components, inflation increased by 0.4% on the month and by 3.9% annually as housing costs—which tend to lag what is happening in the real economy—increased by 0.6% on the month and by 4.6% from a year ago.

The policy-sensitive owner’s equivalent rent series increased by 0.6% monthly and by 6.2% annually, while the cost of shelter jumped by 0.6% and 6% using those same metrics.

Policy implications

Disinflation, which has been primarily in the food, fuel and goods categories, did not broaden out in January as service costs increased by 0.7% on the month and by 4.9% from one year ago.

Services excluding energy also increased by 0.7% and 5.4%, respectively, while the supercore index, or services excluding housing, increased by 0.2% and 4.3%.

Stubborn housing inflation, along with evidence that disinflation is not yet broadening out into services and the supercore metric, strongly imply that the Federal Reserve will remain patient on rate cuts.

One of the main takeaways from the January pricing data is that any idea of a March rate cut should be quietly put to bed. In addition, expectations of a large number of rate cuts, or a first 50 basis-point rate cut, should be retired.

While we recognize that the Fed pays far closer attention to the personal consumption expenditures deflator, which has a far lower weighting in housing, we are confident that the slower descent in the CPI will factor into upcoming Fed decisions.

We are comfortable with our forecast that the Fed will begin its rate cuts in June, with a total of four 25 basis-point rate cuts this year, though there is the chance of three or fewer cuts as inflation improves slowly and the economy outperforms expectations.

The data

Energy costs declined by 0.9% in January and by 4.6% from one year ago while used car and truck prices dropped by 3.4% on the month and by 3.5% on the year.

The outright deflation in those costs is emblematic of the disinflation across the goods sector and the outright deflation in energy costs.

Elsewhere, apparel costs dropped by 0.7%, overall transportation costs fell by 0.6% and commodity prices declined by 0.3% in January. The price of new vehicles was flat on the month and was up by only 0.7% from a year ago.

Food costs, along with food and beverage costs, both increased by 0.4% on the month and by 2.6% from one year ago. Food away from home was up by 5.1% from one year ago.

Egg prices, which are symbolic of the price shocks over the past three years, increased by 3.4% in January but fell by 28.6% from one year ago.

The price of meat, poultry and fish was down by 0.2% over the past year, and the cost of milk fell by 2.4% from one year ago. Fruits and vegetables increased by 1.1% from one year ago. Alcoholic beverages declined by 10.7% from one year ago.

Medical costs advanced by 0.5%, as did recreation costs, while education and communications prices advanced by 0.4% in January.

Airfares increased by 1.4% in January and have declined by 6.4% over the past year.

The takeaway

Disinflation continued to be clustered primarily in the energy and goods sector as it broadened out into food at home. The improvement in inflation helping workers who through January benefited from a 1.4% increase in inflation-adjusted average hourly earnings.

The improvement in inflation-adjusted wages supports overall spending and will put a floor underneath the economy this year as it slows from the robust 3.1% pace of growth last year.

But that disinflation in the energy and goods sectors did not take place in the service sector, where inflation continues to be sticky because of the slow decline in overall housing costs.

The lack of that broadening out will serve as a deterrent to central bankers launching their long-awaited rate cut campaign. Our baseline forecast on rates this year features a June start to the Fed’s rate cut campaign, four 25 basis-point rate cuts and a year-end target of 4.2% in the 10-year Treasury yield.

We are comfortable with that forecast.

This article was written by Joseph Brusuelas and originally appeared on 2024-02-13. Reprinted with permission from RSM US LLP.
© 2024 RSM US LLP. All rights reserved. https://realeconomy.rsmus.com/cpi-fed-to-remain-patient-as-real-wages-rise-1-4/

RSM US LLP is a limited liability partnership and the U.S. member firm of RSM International, a global network of independent assurance, tax and consulting firms. The member firms of RSM International collaborate to provide services to global clients, but are separate and distinct legal entities that cannot obligate each other. Each member firm is responsible only for its own acts and omissions, and not those of any other party. Visit rsmus.com/about for more information regarding RSM US LLP and RSM International.