Avoiding a Government Shutdown, A Benign Inflation Report; A Look Ahead to March FOMC

This morning, the market appears optimistic the U.S. government can avoid a shutdown after Senate Democratic Leader Chuck Schumer reportedly dropped his objection yesterday to the latest spending bill proposal.?

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Recall, the bill initially passed the House on March 11. The proposal that will fund the government for six months through September 30 includes a $6 billion increase in defense spending and a $13 billion cut in domestic nondefense spending.

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Yesterday, on the economic calendar, the PPI was unchanged (0.0%) in February following an upwardly revised 0.6% gain in January. According to the median forecast, the PPI was expected to rise 0.3% in February. Year-over-year, producer prices rose 3.2% in February, a tenth of a percentage point less than expected and the smallest annual increase in three months.

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Food prices rose 1.7% following a 1.0% gain the month prior, while energy prices declined 1.2% in February following a 1.8% increase in January. Thus, excluding food and energy costs, the core PPI unexpectedly fell 0.1% in February, the first monthly decline since July. According to the median forecast, the core PPI was expected to rise 0.3%. Year-over-year, the core PPI increased 3.4% in February, less than the 3.5% gain expected, and a three-month low.

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Additionally, services costs fell 0.2% due to a 1.0% fall in trade costs, and no change (0.0%) in transportation and warehousing costs in the second month of the year.

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On Wednesday, the CPI rose 0.2% in February, a tenth of a percentage point less than expected and a downtick from a 0.5% increase in January. At 0.2%, this marks the slowest pace in four months.?Year-over-year, consumer prices rose 2.8%, also a tenth of a percentage point less than expected and the first month of cooling following four consecutive months of acceleration. At 2.8%, this marks the smallest annual gain in three months.

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Food prices rose 0.2% as did energy prices in February following a 1.1% gain in January. Excluding food and energy costs, the core CPI rose 0.2% in February, a tenth of a percentage point less than expected and following a 0.4% increase at the start of the year.?Year-over-year, the core CPI increased 3.1%, again, a tenth of a percentage point less than expected and marking the smallest annual increase since April 2021.

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In the details of the report, apparel prices climbed 0.6%, the largest gain in five months, and shelter prices increased 0.3% with a similar gain in the OER in February, and marking the fourth consecutive month of a 0.3% gain in the OER. Also, medical care prices rose 0.3%, the largest monthly gain in three months, and commodities prices increased 0.1% in the second month of the year. On the other hand, transportation prices fell 0.8% in the second month of the year with airline fares dropping 4.0%, the largest decline in eight months, and new car prices slipping 0.1% February. Used cars and truck prices, however, increased 0.9% following a 2.2% rise the month prior.

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Another iteration of inflation, the supercore – defined as core services excluding housing – rose 0.2% in February following an 0.8% rise the month prior. Over the past 12 months, the supercore increased 3.8%, down from the 4.1% annual increase in January and marking the smallest annual increase since October 2023.

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Bottom Line:?A?cooling PPI report yesterday on the heels of Wednesday’s cooler-than-expected CPI?is a vast improvement. Still, while a welcome directional adjustment, after several months of accelerating price pressures, one month’s reprieve does little to instill confidence of a sustained disinflationary trend, particularly as some of the larger monthly gains in the report suggest some further price pressures to come (particularly in next month’s PCE report).

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From the Fed’s perspective, while a step in the right direction, with nominal inflation still elevated and fears of emerging weakness in the labor market still largely unfounded, monetary policy is likely to remain unchanged, at least in the near term, as the Committee continues to assess the evolution of the data and the impact of fiscal policy initiatives.?That being said, amid rampant uncertainty and unease, any further reprieve in prices could open the door for additional rate relief in the coming months, as policy has not yet moved into neutral territory, and this is a Committee arguably desperate to provide support to avoid a meaningful downturn in activity.?

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The market, meanwhile, is increasingly convinced the Fed will in fact provide additional policy relief by the end of the year. Anticipating between 1-2 rate cuts throughout 2025 back in January, federal funds futures suggest investors now expect about three rate cuts in the remaining nine and a half months of the year.?

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Along with the PPI, yesterday, initial jobless claims unexpectedly fell from 222k to 220k in the week ending March 8, a three-week low. The four-week average, on the other hand, ticked up from 225k to 226k. Continuing claims, or the number of unemployed individuals who qualify for benefits under unemployment insurance, declined from 1.897M to 1.870M in the week ending March 1, a two-week low.

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This morning, the University of Michigan Consumer Sentiment Index fell 6.8 points from 64.7 to 57.9 in the preliminary March report, surpassing the expected decline to a reading of 63.0 and the lowest print since November 2022.

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In the details off the report, a gauge of current conditions fell 2.2 points to 63.5, a six-month low, and a gauge of future expectations plunged nearly ten points from 64.0 to 54.2 in the preliminary March report, the lowest reading since July 2022, as consumers brace for further uncertainty and potentially higher inflation. In fact, a measure of short-term inflation expectations popped 60bps in the latest report from 4.3% to 4.9%, and a measure of longer-term inflation expectations increased 40bps to 3.9%, the highest in more than three decades.

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Next week, the economic calendar is centered on the latest FOMC rate decision expected Wednesday afternoon followed by Chairman Powell’s comments and updated perspective during the press conference. While widely expected to maintain policy in the current range of 4.25-4.50%, the accompanying communication at next week’s policy meeting could tip the Committee’s hand in terms of primary concerns, a policy lean, and/or expected timeline for any future adjustments in rates.?

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Maintaining a solid assessment of economic conditions and hiring, as well as the still elevated level of inflation, the Fed is likely to show little adjustment in expectations for additional policy adjustments, at least in the near term, as the Committee continues to assess the incoming data and “uncertainty” surrounding tariffs and the Trump administration’s fiscal policy agenda. However, the Committee could opt to lower the caps on monthly portfolio reduction and/or explicitly identify additional factors, including specific fiscal policies, being considered in determining the timing and extent of any additional policy adjustments needed.

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Returning to the economic calendar, on Monday, we’ll take a look at the Empire Manufacturing Index, along with the February retail sales report.

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After a larger-than-expected 0.9% decline in January, the largest drop since March of ‘23, retail sales are expected to rise 0.7%, potentially marking a two-month high. Year-over-year, retail sales are expected to increase 4.1%, potentially marking, however, the weakest pace in three months.

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On Tuesday, we’ll take an updated look at the housing market with February housing starts and building permits, along with import and export price indices, and industrial production and capacity utilization for February.

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Later in the week, on Wednesday, weekly mortgage applications will be released ahead of weekly jobless claims on Thursday, the March Philadelphia Fed Business Outlook Index, the Leading Index for February, and existing home sales.

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Wrapping up the week on Friday, while there are no economic releases to speak of, we will hear from New York Fed President John Williams, as the first to speak out in the aftermath of the Wednesday rate decision. Given all of the “uncertainties” in today’s market, Williams has been clear he is still supportive of where policy currently stands, but going forward, fiscal policies, regulatory policies, and other factors will play deciding roles in the unknown pathway for rates.?

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-Lindsey Piegza, Ph.D., Chief Economist