January CPI Still Indicates a Strong Economy

The U.S. Bureau of Labor Statistics reported Thursday morning that the Consumer Price Index (CPI) advanced 0.1% in January on a seasonally adjusted basis, missing expectations for a 0.2% monthly advance following December's 0.2% monthly gain. Over the last 12 months the CPI has increased 2.5% before seasonal adjustment, exceeding the 2.4% consensus and representing an acceleration versus the 2.3% rate seen in December. Notably, the annual increase was the largest since the 12-month period that ended October 2018. 

The core CPI, which excludes food and energy costs due to their volatility, rose 0.2% in January, matching expectations of 0.2% and following a 0.1% advance in December. Over the past 12 months core CPI has risen 2.3%, exceeding expectations for a 2.2% increase and on par with the annual advances seen in October, November and December.

Source: U.S. Bureau of Labor Statistics, Consumer Price Index - January 2020

As a reminder, core CPI can be viewed as one proxy for inflation. However, the core PCE (personal consumption expenditures) price index is the Fed's preferred gauge. As a result, we believe the annual rate of advance seen in January represents an economy that continues to advance at a healthy clip. While the core CPI index may be tracking above the Fed's 2.0% inflation target, we remind members that the core PCE price index registered a 1.6% annual rate of advance in December (the most recent release). As a result, we do not believe this reading on its own justifies a more hawkish stance by the Federal Reserve, especially when we take into account that the manufacturing sector remains weak despite the small rebound seen in the most recent PMI release (here) and more importantly the overhanging unknown impacts of the coronavirus, which Fed Chairman Jerome Powell addressed in his prepared remarks before Congress earlier this week (here). During that appearance he stated, "We are closely monitoring the emergence of the coronavirus, which could lead to disruptions in China that spill over to the rest of the global economy." 

Digging deeper, the energy index fell 0.7% in January, with the energy commodities index decreasing 1.6% and the energy services index increasing 0.6% on the month. This follows a 1.6% advance for the energy index in December. The food index ticked up 0.2% in January following a similar advance in December. Within the food index, the food-at-home index increased 0.1% while the food-away-from-home index (not seasonally adjusted) increased 0.4% monthly. Over the last 12 months, the energy index has increased 6.2% while the food index has gained 1.8% from the same time last year.

Source: U.S. Bureau of Labor Statistics, Consumer Price Index - January 2020

Thursday's CPI numbers come ahead of next week's Wednesday release of the January Producer Price Index (PPI). As a reminder, the PPI measures price changes from producers' perspectives, while the CPI gauges price changes from the consumers' viewpoint. 

The two indices tend to be correlated, as producers and retailers often pass cost increases on to the consumer. But divergences can occur as the two indices track slightly different metrics. For example, CPI includes imports and owners' equivalent rent -- two metrics excluded from the PPI. Another difference is taxes, which consumers pay on purchases and are included in CPI but excluded from PPI because they aren't a part of producer revenues. 

All in, and as we've noted previously, while the core CPI index remains slightly ahead of the Fed's target inflation rate we reiterate that the preferred reading for the Fed is the core PCE price index. We continue to believe that given the more tempered inflation rates seen in the core PCE, the still beaten-down manufacturing sector and very real risks posed by the unknown impact of the coronavirus, the Fed has no reason to become more hawkish in the near term. With that in mind, we believe the healthy rate of advance also indicates a resilient and growing U.S. economy, causing us to remain optimistic in our outlook on the market, though we will continue to maintain our more defensive stance (as indicated by our higher cash levels) believing that a period of consolidation or profit-taking makes sense as the virus appears to be impacting international activity -- think foreign sales numbers in the first quarter, especially for those companies operating in China.

Members interested in digging deeper or learning more about what the CPI measures and how it is derived can view the U.S. government's official release here.