Thursday, January 12, 2023
We received our final reading on Consumer Price Index (CPI) inflation for 2022 this morning, which gave us the inflation numbers for December 2022. Helped by declining energy prices, the index fell 0.1% in December, in line with economists’ consensus expectation and the largest monthly decline since April 2020. Consumer inflation advanced less than 1% over the second half of 2022, although the fight against inflation is far from over.
Year over year, inflation fell to 6.5% in December, down from 7.1% in November, in line with the consensus expectation. But as seen in the LPL Chart of the Day below, most of that advance came over the first half of the year, which will roll off the year-over-year number as we advance into 2023. The index only advanced 0.9% over the last six months of the year, the lowest six-month reading since late 2020.
However, just as inflation readings were lifted in the first half of the year by rising energy prices, they have been pulled lower by falling energy prices. Core inflation, which excludes food and energy, also slowed over the second half of the year, but less dramatically. Core inflation climbed 0.3% in December and overall slowed from 3.4% over the first half of 2022 to 2.2% over the second half.
The early reaction to the largely in line numbers from both stock and bond markets was muted, with market participants already pricing in expectations for further slowing over the last few trading days. But it can take time for markets to fully digest the report and we’ve seen large swings on CPI day over the last year. According to Bloomberg analysis, the S&P 500 moved an average of 1.9% on CPI day in 2022, about three times the average over the prior five years. A line-up of Federal Reserve (Fed) speakers today may also shape the reaction over the rest of the day.
Some other highlights from this morning’s report:
- Energy prices fell 4.5% in December, the fifth decline in the last six months. Because energy prices are volatile, changes don’t provide a strong picture of underlying inflation trends, but it still provides some relief for consumers.
- Monthly increases in shelter prices, up 0.8% in December, continue to be a large contributor to core inflation. But as noted by Fed Chair Jerome Powell, shelter prices tend to react to the real-time price environment with a lag and can be somewhat discounted when looking at underlying trends.
- While food costs overall increased 0.3% in December, prices for dairy and fruits and vegetables fell.
While inflation has slowed, the Fed is still fighting several important battles to make sure we don’t experience the yo-yo inflation of the 1970s. Inflation expectations can impact prices and some of the Fed’s steadfast inflation-fighting rhetoric has been to keep inflation expectations well anchored, something they’ve largely succeeded at thus far. Labor markets also remain fairly tight despite slow economic growth. While the Fed doesn’t want to unnecessarily damage the economy, getting inflation levels sustainably back toward their long-term trend will probably require wage gains to slow further. Finally, a strong dollar helped control inflation for U.S. consumers by making goods from abroad less expensive. A weaker dollar may create some added inflationary pressure.
The Fed will continue to have a lot of leeway to focus on inflation as long as labor markets remain relatively strong. The Fed’s “dual mandate” is low and stable prices and maximum employment. While growth has slowed, labor markets remain strong. Job creating has slowed but labor demand is still adding to wage pressure and the unemployment rate remains quite low at 3.5%. But bottom line, the weakening trend of inflation should convince the Fed to further downshift the pace of rate hikes in the upcoming meeting. The Fed will likely hike rates by 0.25% on February 1. The labor market must significantly cool before the Fed could appease markets by cutting rates the latter half of this year. Our base case is the economy will slow enough for the Fed to consider cutting rates sometime in the second half of this year.
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