Prices of certain goods that were in high demand during the pandemic, such as used cars and trucks, continued to ease amid a broader shift in consumer spending from goods back toward services.
But beneath the headline readings, the data suggest that inflation is moderating less swiftly than had been hoped by economists. Together with the unexpectedly strong January jobs report, the latest inflation print adds to the risk that the Federal Reserve may have to do more to ease price pressures.
Certain measures of inflation are moving in the wrong direction. On a month-over-month basis, the January consumer price index (CPI) accelerated to 0.5% from 0.1% in December, due largely to a 0.7% rise in the cost of shelter. Meanwhile, core CPI, excluding food and energy, held steady at 0.4%. The data included evidence that inflation was also broad based. The Cleveland Fed’s trimmed mean, a gauge that strips out the biggest price moves, rose 0.6% on the month—the fastest pace since September. Finally, inflation has been trending higher in recent months, with the three-month annualized rate rising to 4.6% in January from 4.3% in December. The six-month annualized rate also ticked higher to 5.3% from 5.1%.
The strength of the labor market is adding to concerns that wage growth will remain too high. The US economy created 517,000 net new jobs in January, more than twice the consensus forecast of 188,000, while the jobless rate fell to a 53-year low of 3.4%. Demand for labor continues to exceed supply, with the JOLTS data for December showing 1.9 openings for every unemployed person.
While there are some signs of slowing wage growth, the pace is still too fast to be consistent with a return to the Fed's inflation target. Although average hourly earnings growth for January weakened to 4.4% year-over-year from 4.8% the month prior, this was still above expectations of a 4.3%rise. In addition, the three-month moving average of median wage growth was 6.1% in January, based on data from the Atlanta Fed, well above the range of 3% and 4% between 2015 and late 2021.
Top Fed officials have stressed that more needs to be done to curb inflation. New York Fed President John Williams said on Tuesday "with the strength in the labor market, clearly there are risks that inflation stays higher for longer than expected, or that we might need to raise rates higher." Dallas Fed President Lorie Logan said the central bank “must remain prepared to continue rate increases for a longer period than previously anticipated,” while Richmond Fed President Thomas Barkin added that there’s “a lot more persistence to inflation than maybe we’d all want.”
We do expect an inflection point in inflation, monetary policy, and market sentiment in 2023. However, the latest data suggest it is too early to expect a dovish pivot from the Fed. With the next FOMC meeting taking place on 21-22 March, it’s unlikely it will have sufficient reasons by then to stop hiking rates. On the contrary, Fed officials may even lift their growth forecasts and the projected rate path trajectory for 2023.
Against that backdrop, we like strategies that provide exposure to equity market upside while adding downside protection. We incorporate a combination of defensive (consumer staples and healthcare), value, and income opportunities that should outperform in a high-inflation, slowing-growth environment, alongside select cyclicals that should perform well as and when markets start to anticipate the inflections.
Main contributors - Mark Haefele, Patricia Lui, Vincent Heaney, Christopher Swann, Jon Gordon, Alison Parums
Content is a product of the Chief Investment Office (CIO).
Original report - Fed may have more work to do to tame inflation, 15 February 2023.
