Inflation: don’t cheer yet

Good morning. The market did not crash on fears of stagflation yesterday, after a colder than anticipated consumer price index report (more on that below). But there is still plenty of tariff uncertainty for investors to contend with. Europe and Canada retaliated against Washington yesterday, after the US’s global aluminium and steel tariffs went into effect; more countries may respond soon. What those responses will be is anyone’s guess, and no one knows whether they will bring President Donald Trump to the negotiating table or invite more retribution. If you had to tariff one US good, what would it be? Email me your pitch: aiden.reiter@ft.com.

CPI

The sound you just heard was the market breathing a sigh of relief. Despite worries that yesterday’s CPI report would come in hot and signal impending stagflation, it came in colder than expected. The headline reading fell from 3 per cent in January to 2.8 per cent in February, and core slid from 3.3 per cent to 3.1 per cent — putting it below December’s relatively cold reading of 3.2:

The turnaround from last month’s hot reading is starker when looking at Unhedged’s preferred measure, the annualised change in month-on-month core CPI:

The annualised change was 2.8 per cent in February, making January’s 5.5 per cent surge look like an anomaly — or, perhaps, a result of the so-called January effect, the occasional inability of the index’s seasonal adjustments to cope with the annual price increases that occur at the start of every year.

Many of the price pressures that pushed last month’s reading up have subsided. Used car and truck price inflation cooled off, as did price rises for shelter and car insurance. Some even reversed: airline fares, which rose 1.2 per cent in January, were down by 4 per cent last month. Equity investors took this all as good news. The S&P 500 finished slightly up, after falling for two consecutive days, and cyclical stocks — specifically info tech and consumer discretionary — posted recoveries.

But before the equity market gets ahead of itself, it must be noted: this was not a particularly good report. By our preferred measure, inflation was higher in February than in December, the last time we said things were cooling off. We’ve been more or less stuck since the autumn, and things could be heating up again. Take shelter inflation, a big part of the index which often lags behind other price categories:

It’s been extremely jumpy for the past few months. Though February’s one-month annualised reading was below the January pick-up, shelter inflation was higher in February than in December and September, when Unhedged and many other pundits called time of death on housing inflation.

There were also some bad numbers lurking in yesterday’s data. The Federal Reserve tends to prefer PCE as an inflation measure over CPI. As Thomas Ryan at Capital Economics said in a recent note, “the components [from CPI] which feed into the Fed’s preferred PCE price index rose more sharply” in February, as compared to January. In particular, computer services and accessories, jewellery, and household appliances came in hotter than expected, as did a few prices linked to services; all three goods categories have very low weightings in CPI, but make up a larger portion of PCE, according to Omair Sharif at Inflation Insights. As a result, many analysts and banks have dialled up their PCE expectations for later this month.

Investors seem attuned to this — though moves in Treasuries and futures markets were muted. Break-even inflation, or the market’s expectation of inflation, ticked up two basis points yesterday, driving a three basis point increase in 10-year Treasury yields. Futures implied rate cuts by the Fed were downgraded, too. More market participants started betting on fewer rate cuts than Wednesday’s consensus of three 25 basis point cuts by year end:

We may have avoided an immediate market meltdown. But the inflation picture is mostly unchanged. We could still see the effects of tariffs passed through to consumers. And, on the whole, prices look hotter than just two months ago. This was just a momentary reprieve of stagflation fears, not a salve. Today’s PPI should also be revealing.

Two Sessions

On Tuesday, China concluded its most important annual gatherings: the National People’s Congress (NPC) and the Chinese People’s Political Consultative Conference (CPPCC), colloquially the “Two Sessions”. The meetings coincide every year, and provide the government an opportunity to present its…