INSIGHTS

On March 14, 2023

Don’t Forget About Inflation

While the market has focused on the collapse of Silicon Valley Bank and Signature Bank, the March 14 Consumer Price Index (CPI) report shows that the Federal Reserve (Fed) is making progress on taming inflation, but still has work to do.

CPI has been improving, but perhaps slower than the Fed would like

CPI and Core CPI edged down to 6.0% and 5.5%, respectively, from a year ago, the lowest since the tail-end of 2021, albeit still representing a relatively slow rate of descent (Figure 1).

Core services continued to strengthen while core goods disinflation continued. Food price inflation has shown signs of easing but remained elevated.

Figure 1: CPI has been falling, but at a slowing pace

The Fed’s closely watched “super core” inflation measure (core services excluding housing) continued to run strong at 6.1% year-on-year, despite a drag from medical services (partly due to a measurement quirk); transportation services was up 14.6%, with the airline sector in particular grappling with labor shortages.

Meanwhile, shelter inflation was once again the largest contributor and showed no signs of slowing down — up 8.1% year-on-year. We expect shelter inflation to slowly decelerate sometime later this year given its ~12–18-month lag to private rental indices.

Figure 2: Most elements of CPI have been slowing, outside of shelter, which has been increasing

Signs of hope from small businesses

Meanwhile, consumer inflation expectations remain somewhat elevated for both the one and five years, with consumers expecting inflation to be ~6% one year from now, in line with current levels.

Figure 3: Consumer inflation expectations elevated

At the same time, the latest National Federation of Independent Business (NFIB) small business survey showed the net percent of small business owners expecting to raise prices over the next three months has fallen four percentage points to 38%, the lowest level since April 2021 (Figure 4).

Figure 4: Small businesses have shown easing cost constraints

The Fed’s challenge will likely be complicated by recent volatility

The Fed will publish its highly anticipated refreshed “dot plot” and economic forecasts later this month. We still see a terminal Fed Funds rate between 5% and 5.5% (from the current mid-point of 4.625%) as a reasonable base case.

We do not believe the turmoil related to Silicon Valley Bank and Signature Bank is a systemic event, but it will have the potential to drive market uncertainty for some time. We believe a 25 bps (basis point) hike at the next Fed meeting is still a likely outcome.

In contrast to market pricing, we believe a “pivot” to rate cuts by year-end remains unlikely. Inflation is moving in the right direction but, with wage-sensitive “super core” inflation still running strong and the ongoing tightness in the labor market, we expect the Fed to remain committed to its mission to tame the inflation problem.

Rather than using interest rates, we expect the Fed to address banking sector confidence through its liquidity operations, particularly the newly-introduced Bank Term Funding Program (BTFP). The BTFP was created to support American businesses and households by making additional funding available to eligible depository institutions to help assure banks have the ability to meet the needs of all their depositors. Additionally, if volatility were to deepen further, it might consider slowing or pausing its quantitative tightening operations to help cushion market volatility.

CRN: 2023-0313-10736 R

The opinions and views of this commentary are that of Insight Investment and are not necessarily that of Advisors Asset Management. Any forecasts or opinions expressed herein are Insight Investment's own as of March 14, 2023 and are subject to change without notice. This information may contain, include or is based upon forward-looking statements. Past performance is not indicative of future results.

The Consumer Price Index (CPI) is released by the Bureau of Labor Statistics as a measure of the average change over time in the prices paid by urban consumers for a market basket of consumer goods and services.