The February 2024 Consumer Price Index for All Urban Consumers (CPI-U) report marked a second consecutive 0.4% month-over-month (MoM) increase in February, following a 0.3% rise in January. On a year-over-year (YoY) basis, inflation rose by 3.2% in February, a slight uptick from the 3.1% YoY rise in January.¹ While the slightly stronger February CPI report was unwelcome news for the Federal Reserve, underlying components still indicate a promising trend in inflation, and the report was largely in line with expectations.

CPI prints play a key role in the Fed’s interest rate decisions as it continues its goal to lower inflation to its 2% target. We don’t expect February’s CPI print to alter the Fed’s plans to keep rates higher for longer until inflation materially lowers. The Fed needs to see more compelling evidence that inflation is nearing 2% before beginning rate cuts.

Report highlights

February’s stronger YoY rise in the headline CPI suggests the path to the Fed’s 2% target could be longer and bumpier than expected, as the labor market and economic growth remain too strong, elevating prices. On a positive note, food prices were unchanged in February, following a 0.4% MoM increase in January. Food at and away from home were also unchanged in February.

However, these prices were offset by a sharp 3.8% MoM rebound in gasoline prices in February, following declines the prior two months.² Although energy prices are volatile, February’s rebound could suggest disinflation from declining energy prices may be close to an end. We expect energy prices will keep headline inflation data elevated in the near term and weigh on the consumer by diminishing purchasing power.

Core CPI (excluding food and energy) rose by 0.4% MoM again in February and a slightly softer 3.8% YoY.³ The increase in the core CPI was driven by robust gains in owner’s equivalent rent and medical care services prices. We expect that core inflation will moderate this year as the economy and labor market soften; however, it will likely take longer to reach the Fed’s goal as services inflation remains sticky.

Core services inflation also remains on the stickier side of inflation, which the Fed is laser-focused on slowing. Core services inflation fell to 0.5% MoM in February, weighed down by a softer 0.4% MoM rise in the shelter component. There was a slight uptick to 0.5% MoM in rent of primary residence inflation and a more muted 0.4% MoM rise in owner’s equivalent rent.⁴

While the shelter component slightly moderated, it remains the main driver of core services inflation and accounts for one third of the overall CPI. Shelter prices need to decline for headline inflation to materially weaken. Although changes in housing prices have a lagged effect on the housing component of the CPI basket, we expect rental prices to soften this year.

Core goods prices increased 0.1% MoM in February, following a 0.3% MoM decline in January. This rise was driven by a 0.1% MoM rise in used vehicles prices, which offset the 3.4% MoM decline in January, and a 0.6% MoM rise in apparel prices, which offset a 0.7% MoM decline the prior month.⁵ We expect the price of goods to moderate in upcoming quarters as consumer demand further weakens due to high interest rates and tighter monetary policy.

The Fed remains focused on its new preferred measure of inflation, core services inflation (excluding housing), which rose by 0.5% MoM in February, following a 0.9% MoM rise in January. February’s gain is more than twice the pre-pandemic pace and remains too strong for the Fed. Largely driven by the domestic economy, this indicator indicates economic growth is still too high for inflation to return to the Fed’s 2% inflation target.

Possible implications for the Fed

We don’t expect February’s CPI report to alter the Fed’s plans to keep interest rates higher for longer to slow inflation. February’s CPI report showed inflationary pressures are continuing to ease, especially compared to the 6% YoY headline inflation rate in February 2023.⁶ However, it will take time to reach the Fed’s 2% inflation target.

Energy and shelter inflation need to fall significantly lower. That said, we expect many disinflationary pressures to feed through and bring down inflation this year, especially given the decline in unit labor cost growth to its pre-pandemic rate. These factors will play a key role in determining the Fed’s monetary policy decisions in 2024, which will be critical in shaping the economic outlook for both consumers and markets.

On March 7 at Fed Chair Jerome Powell’s semi-annual monetary policy testimony, Powell indicated that the Federal Markets Committee (FOMC) will consider cutting rates at some point later this year and will continue its data-dependent approach. February’s inflation report provides some evidence that inflation is trending in the right direction, but it might not be enough to convince the Fed to lower interest rates anytime soon.

The bottom line

We still expect the Fed to begin cutting interest rates later in the year. At the most recent FOMC meeting in January, the Fed suggested it would likely cut rates three times if inflation and economic growth continue to moderate. For more information on how this economic data may impact your investment strategy, consult a financial advisor.