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The consumer price index showed firm price pressures in February, as the annual CPI inflation rate matched expectations of 6% and the core CPI came in hotter than expected. While persistently high inflation might support the case for a rate hike next week, Fed officials may still punt as they try to shore up confidence in the banking sector. The S&P 500 rallied strongly in early Tuesday stock market action after the CPI report.


CPI Inflation Report Hits And Misses

The CPI inflation rate eased to 6%, down from 6.4% in February and in line with forecasts. The consumer price index rose 0.4% on the month.

The core CPI, excluding food and energy, rose 0.5% vs. January levels, above 0.4% forecasts. The annual core inflation rate unexpectedly held at 5.5% vs. forecasts of 5.4%. The core CPI inflation rate peaked at a 40-year-high 6.6% in September.

Fed Chair Jerome Powell has said that the most important category of spending for the inflation outlook is core nonhousing services, reported with the Commerce Department’s late-month personal income and outlays data. Wall Street views the CPI gauge of services less rent of shelter as a reasonably close proxy, but it has serious shortcomings.

February’s CPI showed services less rent of shelter prices rising just 0.1% on the month and 6.9% from a year ago vs. 7.2% in January. However, a 0.7% drop in the cost of medical care services distorted the figure. That reflected a 4.1% monthly drop in the cost of health insurance. But the CPI report’s methodology focused on health insurer profits from the previous year doesn’t yield a timely, useful data point.

Fed Policy Impact

Ahead of the CPI report, markets were pricing in about 64% odds of a quarter-point rate hike at next week’s Fed meeting. But that jumped to 77.5% after the CPI inflation data, with just 22.5% odds of no hike.

That still marks a stark change from a week ago, when odds of a half-point hike were around 70% after Powell put a bigger move on the table.

The data has remained pretty hot. But the failure of three banks in recent days has stoked concern about broader financial-sector stress. The Fed and other banking regulators pulled out a bazooka over the weekend, guaranteeing even noninsured deposits at SVB Financial Group’s Silicon Valley Bank and Signature Bank (SBNY).

The Fed also announced a one-year bank term funding program to offer small and midsize banks a solution to a key problem that had plagued SVB Financial (SIVB). If the new Fed program had been in place, SVB would have been able to tap a Fed loan by putting its fallen bonds up as collateral, avoiding the need to sell at a loss.

Still, bank stocks remained under pressure on Monday. Federal officials said the rescue of SVB and Signature Bank depositors will eventually be paid for by higher deposit insurance fees from covered banks. There’s also concern that banks will have to offer customers better deposit terms to limit outflows with short-term Treasury yields still above 4%.

Hard hit bank stocks rebounded Tuesday morning, including First Republic Bank (FRC), but are still down massively over the past week. A surprise Fed rate pause might help stanch the bleeding. The Fed also issues new economic projections next week. Policymakers could decide to pause in March but signal that a couple of more rate hikes are still expected.

S&P 500 Reaction To CPI Report

After the CPI report, the S&P 500 rose 1.7%. The S&P 500 slipped 0.15% on Monday, closing at a two-month low.

Meanwhile, the 10-year Treasury yield rose 11 basis points to 3.63%.

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CPI Report Details

Core goods prices rose were unchanged on the month. That lowered the 12-month goods inflation rate to 1% from 1.4%.

Energy prices dipped 0.6% on the month and are now up 5.2% from a year ago vs. 8.7% in January.

Prices for food at home rose a more moderate 0.3% on the month, while food at home prices increased 0.6% from January.

The CPI report showed used car prices falling 2.8%, while new vehicle prices rose 0.2%.

Apparel prices jumped 0.8% and are now up 3.3% from a year ago. Transportation service prices rose 1.1%.

CPI Proxy For Core Nonhousing Services

It is possible to construct an inflation index out of the CPI that bears some relation to the core nonhousing services category highlighted by Powell.

Start with services less rent of shelter. Subtract energy services and health insurance (which is derived from last year’s health insurer profits). Then add lodging and food services. In February, the CPI proxy for core nonhousing services saw prices rise a hefty 0.6% on the month, while the 3-month annualized inflation rate accelerated to 6.7%.

This CPI category covers just 29% of consumer outlays, while PCE core nonhousing services covers 50% of household spending. In other words, there are still huge differences. Health care is a glaring one, since it accounts for nearly 16% of PCE spending, while medical services amounts to less than 7% of CPI budgets.

The best clue to PCE health services inflation won’t come from the CPI but from Thursday’s producer price index. The PPI medical services component feeds directly into the PCE.


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