Tuesday, March 14, 2023
- The monthly consumer inflation rate slowed slightly to 0.4% in February from 0.5% the previous month, enough to push the annual rate of inflation down to the lowest since mid-2021.
- Housing costs accounted for over 70% of the increase in February and were the largest contributor to the monthly growth rate. This component will not likely be a significant driver of inflation by year end as more multi-family units come to market.
- Headline annual inflation rose 6%, the smallest increase since September 2021 and should reassure investors that inflation will cool further in the coming months.
- Food inflation rose 0.3% in February, the smallest increase since April 2021. Food prices are convincingly on a downward trend for the past seven months.
- Bottom Line: Even amid current banking scares, the Federal Reserve (Fed) will still prioritize price stability over growth and likely hike rates by 0.25% at the upcoming meeting. Shelter costs are poised to ease as more multi-family units come online throughout the year—as the supply of housing units increase, prices will slow and potentially decline. Investors should expect inflation to improve in the latter half of this year and will likely be interested in taking on more market exposure in portfolios.
First, Fed Will Likely Focus on Price Stability Mandate Over Growth
Investors should expect the Federal Open Market Committee (FOMC) to focus on the inflation portion of the dual Congressional mandate for price stability and full employment, i.e., the growth component of the mandate. Although the markets are still interpreting the risks within the smaller, regional banking sector, as of now, the volatility is contained without major risks of contagion. Unlike the Great Financial Crisis, larger banks are currently well-capitalized and hedged against broader economic risks. Cash holdings at commercial banks are roughly 14% of total assets, 11 percentage points higher than at the beginning of the Great Financial Crisis. Cash on hand will buffer larger banks from some of the risks. Further, the Fed’s new lending facility, the Bank Term Funding Program, is able to provide additional funding for eligible institutions that desire more cash on hand.
A key question for investors is will the fragilities within Silicon Valley Bank spread into the broader banking sector? The answer? Not likely.
Second, Shelter Costs Set to Cool
Monthly shelter costs are accelerating, rising faster than 0.5% every month since January 2022. The annual inflation rate for rent alone is 8.8%, the highest since 1981 when Ronald Reagan was president. However, we do not think this trend will continue. Strong multi-family construction activity is clearly a good sign that rent costs will eventually ease. The growth in condo and apartment construction means the supply of multi-family units will increase this year as more projects come to market. New multi-family projects will likely dampen rents as more properties come online, so we should expect rent prices to decline this year as the supply of units grows. Industry data already shows declining rent prices, so it’s just a matter of time before the official government statistics reflect that easing. Investors and policy makers alike should expect a softening in housing-related inflation in the coming months.
Third, Food Gets Closer to Long-Term Trend
Decelerating food prices prove salve for consumers amid naggingly hot inflation. Food inflation rose 0.3% in February, the smallest monthly increase since April 2021. Grocery prices rose 0.25% in February, but restaurant prices (“Food consumed away from home”) reaccelerated to 0.63% month to month. Labor costs are a key component to restaurant prices, but for those lower income price-conscious consumers who want a good meal at home, chicken prices have outright declined for four out of the last five months.
What Does It Mean for You?
Inflation fighting is still the Fed’s main focus but the outlook for inflation the rest of the year looks promising. Further, the banking failure of Silicon Valley Bank seems to be contained and the general financial system appears stable. Although we expect another 0.25% increase in the Fed’s target rate at the upcoming meeting, the economy is weakening so conditions look like our baseline forecast this year will come to fruition. That is, the Fed pauses by the summertime, if not sooner, and the economy ekes out slightly positive growth for 2023. As inflation convincingly cools closer to the long-run target of 2%, investors will likely take on more risk for their portfolios.
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