The February inflation data was, on the margin, better than expected, and so was the January JOLTS report. However, both data points have diminished relevance amid the onslaught of policy changes—tariffs and government layoffs—that have the potential to shift the tenor considerably in coming months. Forward looking indicators like the Michigan consumer sentiment index highlight the risks: consumer confidence continues to plummet, and inflation expectations are surging.
Be that as it may, we’ll still happily take a lower than expected inflation print over the opposite. Overall and core (excluding food and energy) prices rose 0.2% m/m, allowing the corresponding measures of inflation to cool by two tenths each, to 2.8% and 3.1%, respectively. The good news is that for core inflation this was the lowest print since April 2021. The bad news is that there will be little (if any) further progress in the next few months.
Food and energy prices were well behaved, up 0.2% m/m each. Services rose 0.3% m/m, easing back from January’s hot 0.5% monthly gain. This allowed services inflation to ease one tenth to 4.1% y/y, the lowest level since December 2021. Not every category within services moved lower, but rent of shelter (down a tenth to 4.3% y/y) and transportation services (down 2.2 percentage points to 6.1%) helped offset slight acceleration in medical care services and other services (each category accelerated 0.3 ppt to 3.0% y/y and 2.8% y/y, respectively). A sizable 4.0% m/m drop in airfares explained the retreat in transportation services inflation. While airlines have recently commented on soft demand conditions, it seems unlikely that such soft readings persist.
New vehicle prices eased 0.1% m/m while used car vehicle prices rose 0.9% m/m. This marked the sixth consecutive month of rising used vehicle prices, following a string of six consecutive declines prior. At this point, used vehicle price inflation in the CPI sits marginally above the y/y increase in the Manheim auction price index, so the “catch-up” period should be over.
There is simply too much chaos around tariff policy now to be able to confidently assess ultimate impact on US inflation. We are working on an assumption of 40-50 bp ultimate impact on core PCE inflation, which still seems reasonable despite the aggressive opening gambit by the US administration on the trade front. We still believe there is room for the Fed to cut three times this year, a view we had maintained since Q4 last year and that had since been in and out of favor in the marketplace. We look for the next cut in June, which would mark a 6-month pause since the last reduction in December. Next week’s FOMC Summary of Economic Projections (SEP) will likely maintain the 2-cut median, but we expect increased dispersion within the “dot plot”.
Job openings ticked higher in January (to 7.74 million from 7.51 million in December), but we take little reassurance from that since the reference period was before all the drastic government-sector personnel changes instigated by DOGE. Whether or not some of the announced layoffs are walked back (at least temporarily) following court orders, the idea that the federal government is on a de-facto hiring freeze remains. Even if some of the federal funding cuts are also reinstated (at least temporarily) also due to court orders, the fact remains that funding flows will diminish on a go-forward basis and uncertainty around them has sustainably increased. Hence, there will likely be a fairly quick response from the private sector with hiring freezes of their own, especially in areas like education and life sciences. Meanwhile, tariff uncertainty could also put hiring plans on hold among small businesses, whichis where job openings are still robust.
For a hint on the bumpy road ahead, look no further than the collapse in the University of Michigan consumer sentiment survey. Having risen to an eight month high in December, sentiment has since collapsed, with outsized declines in both February and the preliminary March reading as tariff threats (and DOGE disruptions) intensified. The index lost 6.8 points in March and a cumulative 16.1 since December. At 57.9, it is now at the lowest level since November 2022 (Figure 1, page 3). At the same time, inflation expectations continue to surge, with 1-year inflation expectations up another 0.6 percentage points (ppts) to 4.9% and 5-10 year inflation expectation up 0.4 ppts to a record 3.9%. What is astonishing is the speed with which consumers are responding to tariff concerns this time around. Short term inflation expectations have nearly doubled since November: from 2.6% to 4.9%. There is only one word to describe this: extraordinary! This is certainly one of the factors that could sway the Fed against cutting interest rates, but the one counterpart so far is that business inflation expectations have been much more stable, suggesting that despite tariff threats, pass-through may be much more limited than consumers fear.. Still, this is a critical indicator to watch.
