The real shocker in today’s report on the U.S. Consumer Price Index (CPI) was that the seasonally adjusted core CPI rose by 0.3% month-over-month for the second straight month ‒ for the first time in 15 years. Core CPI is now running at 2.3% year-over-year, which is on the higher side of the more optimistic forecasts.
While headline CPI declined 0.2% in February on a seasonally adjusted basis, the main reason continues to be energy, the U.S. Bureau of Labor Statistics reported today. Over the last 12 months, headline CPI increased 1.0%.
Looking under the hood, the strength was broad-based. Services were up 0.3% month-over-month, with shelter as well as services ex shelter at a steady pace. This is not surprising as we were expecting non-tradable sectors to be supported by the strength of the domestic economy.
A more surprising element from today’s release was the strength in core goods, which rose to 0.1% year-over-year, as we were accustomed to outright deflation. Core goods are usually exposed to global forces and are sensitive to a stronger currency through lower import prices. A stronger U.S. dollar was a clear headwind for most of 2015, but is the negative impact of the strong dollar already fading away? While the U.S. trade-weighted broad dollar appreciated 19% from June 2014 to September 2015, it’s been more stable since. An optimistic reading would be that the impact of the strengthening dollar is now in the rearview mirror as globalization and new technologies have increased the speed of pass-through effects. That said, we’d need more evidence to see this as a trend, especially since apparel was up 1.6%, accounting for most of today’s surprise; this particular gain is unlikely to be sustainable.
To conclude, this is a robust number that should give some confidence to the Fed that it’s on track to finally reach its inflation target of 2%. However, inflation expectations remain low, and late-cycle inflation may not be enough to re-anchor them. The Fed’s communications today seem to confirm this. Just as Alan Greenspan engaged in opportunistic disinflation, this Fed may want to employ opportunistic reflation in order to make up for the long-term undershoot on its target.