At a Dubai conference on Tuesday, International Monetary Fund Managing Director Kristalina Georgieva said she saw a chance of “finally getting on top of the problem of cost of living being a major disruptor for millions and millions of people.” The IMF sees global inflation falling to 6.6% in 2023 and 4.3% in 2024.
In the United States, markets (and some CFOs) expect the central bank to put an end to abnormal price jumps quicker. But maybe they’re expecting too much.
The headline consumer price index (CPI) fell only slightly to 6.4% year over year on Tuesday, reported the Bureau of Labor Statistics (BLS). CPI less the food and energy categories also dipped to 5.6% year over year. But month-to-month CPI increased by 0.5% in January, stronger than expected. (See chart.)
Inflation in the costs of shelter — the largest component of headline CPI and core CPI — remained elevated, as did the price of services. A rebound in electricity and gasoline prices also kept headline CPI from greater easing.
Indeed, corporate executives are wary of declaring the Federal Reserve will win the battle against inflation in short order. “While the inflationary environment appears to be cooling, we are still expecting to see elevated inflation across our operating costs,” said Coca-Cola CFO John Murphy on the beverage giant’s earnings call on Tuesday, as recorded in the S&P Capital IQ transcript.
At a Credit Suisse investor conference the same day, Goldman Sachs CEO David Solomon said he was “in the camp that it's still uncertain exactly what the trajectory will be of tamping down inflation. …. Clearly, the market has a sense that we're putting inflation in the rearview mirror. But I'm less certain and I think it's going to be a twisty-turny kind of road to kind of navigate through this and get to the other side.”
Catalysts for Lower Readings
But there are positive trends, too. As Robert Phipps, director of Per Stirling Capital Management, told CFO in an email, inflation has clearly peaked, and “the decline should be further catalyzed by both the normalization of supply chains and what should be a substantial decline in the ‘shelter’ component of CPI, once the government’s badly-lagging estimates of both rent and owners’-equivalent rent catch up with reality.” (See chart.)
John Lloyd, portfolio manager at Janus Henderson Investors, also pointed out the market expects the shelter category to start trending down based on recent numbers from real-time rental indexes.
Phipps noted that the U.S. is experiencing its first-ever contraction in M2 money supply, “which should be another powerful disinflationary influence.”
Still, after Tuesday’s report, the odds of a 25-basis point increase in the Fed funds rate at the next three Federal Reserve Open Market Committee meetings (March, May, and June) increased. On Wednesday morning, the CME FedWatch Tool measured a 49% probability (the plurality) that the Fed funds target range would be 5.25% to 5.5% after the June 14 meeting (up from the current 4.5%-4.75%).
Tough Fight Ahead
“On net, the disinflation we are seeing remains narrow, driven by a few key core goods components, and it has yet to broaden,” said the research group of BofA Securities in a comment Tuesday. “The Fed will need to see a moderation in services inflation before having confidence that [its target of] 2% is achievable.”
The need to narrow the gap between available jobs and available workers is one of several reasons why the Fed may keep interest rates higher for longer, even if inflation continues its current decline. — Robert Phipps, Per Stirling Capital Management
According to Phipps of Per Stirling Capital Management, the incredibly tight labor market, “where there are almost twice as many jobs available as there are available workers, … is putting considerable upside pressure on wages” as well as on the service sector.
"The need to narrow the gap between available jobs and available workers is one of several reasons why the Fed may keep interest rates higher for longer, even if inflation continues its current decline,” said Phipps.
The nature of how CPI is reported may also come into play. Since the federal government measures CPI on a year-over-year basis, the January number benefited from what is called a “base effect,” said Phipps. “In other words, because inflation was so high a year ago, the January numbers look good by comparison.”
That effect should continue to benefit the CPI numbers in February, March, May, and June, due to the high inflation rates experienced during those months in 2022.
Starting in July, however, year-over-year comparisons will become much more difficult. “That could, all other things being equal, put upward pressure on inflation in the last five months of the year,” Phipps said.