Core Inflation Hits 15-Month Low, Even as Unemployment Falls
Core Inflation Hits 15-Month Low, Even as Unemployment Falls
The Fed warned that unemployment would have to rise for inflation to come down, but the CPI declined outright in December even as unemployment fell to a 50-year low. Even core inflation—the part most directly tied to wage growth—moderated and came in at a 15-month low. Today’s CPI report, combined with recent labor market indicators, increases the likelihood of a soft landing.
Prices declined outright by 0.1% in December, bringing the year-over-year increase to 6.5%—the smallest year over year inflation rate since November 2021. It is the first deflationary reading since the pandemic. The recent moderation in wage growth, evident in last Friday’s jobs report, suggests more good news ahead on the inflation front. Given all economic indicators are moving in the right direction, the Fed is likely to increase the rates by 25 bps in February, substantially slower than the rate hikes we had in 2022.
Here are the the highlights of today’s CPI report:
Food and gas prices are becoming less of a concern: Sudden spikes in gas and food prices following first the global supply chain issues, then the Ukrainian war, were the two biggest contributors to high inflation starting at the end of the first quarter of 2021. In fact, in April 2021, the goods and energy price increases accounted for 60% of overall inflation. As global supply chain pressures eased and energy prices started normalizing, the impact of the two decreased substantially. As of December 2022, the troublesome duo now accounts for just 31% of overall inflation —still an outsized impact historically, but improving. Core inflation remains low, in line with the prior three-month average: Core goods and services prices—the less volatile part of inflation that tells us more about the long-term trajectory of prices—increased 0.3% over the month, aligned with the prior 3-month average change, and 5.7% over the year. But the three main layers of core inflation—core goods, core services excluding shelter, and shelter prices—are not in sync yet.
Core goods prices have been on the decline for the last 3 months. Year-over-year core goods inflation peaked in February 2022—with prices having increased 12.3% over the year—but declined sharply to only 2.1% over the year in December as consumer preferences shifted from goods back towards services as the pandemic impact faded away. Given the steep downward trend, core goods prices are likely to decline further in the next couple of months.
Core services inflation excluding shelter decelerated slightly in December to 6.3% from 6.4% in November, but still remains high as consumer spending on services increases now that the service sector has reopened. But since households are drawing down their excess savings, we should see growth in demand for services ease in the upcoming months, putting downward pressure on service prices.
Shelter prices are still following an upward trend, and have a sizable impact on the topline number. In fact, 2.5% of the 6.5% comes solely from the housing price increases. However, more timely private data from Zillow shows that both house sale prices and rents decreased sharply in the last 2 months. If we substitute the shelter index in the consumer basket with the Zillow rates, the overall prices should decline by 0.4% instead of the 0.1% reported today.
Real earnings increased 5 of the last 6 months. For most of the past two years, inflation has outpaced wage growth and U.S. consumers have seen their purchasing power contract. Now that inflation is falling more quickly than wage growth, consumers are finally experiencing real wage increases again. The purchasing power of Americans’ paychecks increased 0.4% in December, which was a welcome change for holiday shoppers. Positive real wage growth should prop up demand for goods and services going forward and sustain demand for labor, preventing us from falling into a recession.
