January’s inflation report came in hotter than expected, though some of the “surprise” is due to start-of-the-year effects that have become more pronounced in recent years. Volatile hotel prices pushed the all-important shelter category back up to 0.4%, after it had fallen to 0.3% in recent months. Mortgage rates will climb higher today as expectations for further Fed rate cuts are pushed to the fall.
Core prices, which exclude the volatile food and energy categories ignored by the Fed, rose 0.45% from a month ago, faster than the 0.3% expected by forecasters—partly due to start-of-year effects. Compared to a year ago, prices in the core categories are 3.3% higher. Many of the categories where prices increased the most—including car insurance, used cars and recreation—are areas where prices reset in January. With inflation being higher these past few years, the size of the typical January reset has been larger. That means that even though these data are adjusted to account for typical seasonal patterns, the statistical adjustment has not yet caught up to recent patterns and is failing to account for all of the seasonal effect. Some of the outsized surprise in inflation today is real, but much of it will become less of an issue in the coming months.
The all-important shelter category ticked back up to 0.4% after having fallen to 0.3% in the last couple of months, but the increase was due to volatile hotel prices instead of rents. Shelter prices account for 42% of core CPI and, importantly, accounts for all of why inflation is not yet back at target. Market rents have been flat for years, but the official inflation statistics have yet to fully catch up. When they catch up will largely determine when inflation will be back at target, assuming other prices don’t accelerate. The recent drop in shelter inflation has been encouraging and today’s data indicates no further improvement, but also no deterioration in that progress.
Mortgage rates will increase today as investors now anticipate no more Fed rate cuts until the fall. Having already brought the fed funds rate down from 5.5% to 4.5%, the Fed now has to feel around in the dark for where the neutral rate—which neither stimulates nor contracts the economy—is, because it is impossible to know where it is until you’ve run right into or past it. The Fed cannot risk accidentally cutting too much and stimulating the economy when inflation is a little too high, the labor market is strong, and the White House weighs inflationary policies. They would rather hold higher for longer than have to hike again after cutting.
