Mixed Inflation Expectations

Tariffs remain top of mind, sparking a rise in consumer inflation expectations and complicating international relationships.?

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According to reports, the EU is prepared to respond “swiftly and proportionally” to the implementation of additional U.S. tariffs; President Trump has proposed a 25% tariff on steel and aluminum exports, which could take effect as soon as March 12 and impact as much as $29.3B of European exports with the U.S. market the second largest recipient of EU steel.?

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Meanwhile, according to White House officials, tariffs aimed to impact?Canadian and Mexican imports coming into the U.S. are on track and “moving along very rapidly.” Although, while the implementation is scheduled for March 4, team members have?cautioned the official schedule was still being determined.?

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According to the January 28-29 FOMC meeting minutes, there is?a “high degree of uncertainty” surrounding the economy and the potential impact of new fiscal policy initiatives, including tariffs. As such, it is appropriate for the Fed to “take a careful approach” in considering any further changes to its key interest rate, a message of at least near-term patience reiterated by a number of Fed officials in the past few weeks. Fed governor Christopher Waller, for example, said that while he supports?a pause for now, he still expects rates to come down this year. Speaking at an event in Sydney on February 18, Waller was clear that if the recent?uptick in price pressures last month turns out to be temporary, as it did in January 2024, “rate cuts would be appropriate at some point this year.”

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The market, meanwhile, also remains somewhat optimistic regarding the potential for further rate relief, despite the lack of disinflationary progress since September. According to Bloomberg data, investors have ramped up bets on rate cuts with 55bps of cuts priced now priced in by year-end, up from 35bps priced in a week ago, as investors see signs of a weakening economy and the potential for more cuts on the horizon.

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Turning the economic calendar, yesterday, the Fed National Activity Index declined from +0.18 to a reading of -0.03 in January, a two-month low. According to the median forecast, the index was expected to fall to a reading of -0.05. The Chicago Fed Index draws on 85 economic indicators; a reading below zero indicates below-trend growth in the national economy and a sign of easing pressures on future inflation. In January, 39 of the 85 monthly individual indicators made positive contributions, while 46 made negative contributions.

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Also yesterday, the Dallas Fed National Activity Index dropped more than expected, falling from 14.1 to a reading of -8.3 in February, a six-month low. According to the median forecast, the index was expected to fall to a reading of 6.4.

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In the details of the report, new orders fell from +7.7 to -3.5, and production slumped to -9.1 from +12.2 in the second month of the year, the lowest reading in over a year. Also, capacity utilization decreased from +5.0 to -8.7, the lowest reading since January 2023, and employment slipped from +2.2 to -0.7 in January, averaging 0.9 over the last six months. Additionally, hours worked plunged from +1.9 to -14.2, and the six-month general business outlook index declined nearly 28 points to a reading of 7.7 in February, a nine-month low.

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This morning, the FHFA House Price Index rose 0.4% in December, a tenth of a percentage point more than expected and following a similar increase in December. Over the past 12 months, the FHFA House Price Index rose 4.7%, a two-month high.

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Also, this morning, the S&P Case-Shiller 20 City Home Price Index rose 0.52% in December, surpassing the 0.40% gain expected and marking the largest monthly increase since February 2024. Additionally, the National Home Price Index rose 0.46% in December, also marking the largest monthly gain since February 2024. Over the past 12 months, the 20-city index increased 3.96%, the largest annual gain since August, while the national index gained 4.53%, the largest annual increase in three months.

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Additionally, this morning, the Conference Board’s Consumer Confidence Index dropped more than expected, falling seven points to a reading of 98.3 in February, an eight-month low. February’s seven-point decline marks the largest monthly drop since August 2021. According to the median forecast, the index was expected to decline to a reading of 102.5. In the details of the report, a gauge of current conditions declined 3.4 points from 139.9 to 136.5, and a gauge of future expectations slumped 9.3 points from 82.2 to 72.9 in February, marking the largest monthly drop in three-and-a-half-years and the lowest reading since June.

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Finally, this morning, the Richmond Fed Manufacturing Activity Index unexpectedly rose ten points to a reading of +6 in February, the highest reading since April 2022 and following 15 consecutive months of a negative print. According to the median forecast, the index was expected to rise one point to -3.

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In the details of the report, new orders increased four points to a reading of 0, shipments jumped from -9 to +12, and employment rose six points to a reading of +9, the highest reading since August 2022. On the other hand, wages ticked down one point to +21 in the second month of the year, a two-month low.

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Tomorrow, we begin with weekly mortgage applications, followed by the final read of January building permits and January new home sales.

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On Thursday, we turn to weekly jobless claims, and the first highlight of the week – the second-round Q4 GDP report.

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In the preliminary report, GDP rose 2.3% in the fourth quarter, less than the 2.6% gain expected and marking the slowest pace of growth in three quarters. In the second-round Q4 report, GDP is expected be unrevised at 2.3%.

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Also on Thursday, the January durable goods order report will be released. After unexpectedly dropping 2.2% in December, durable goods orders are expected to rise 1.2% in January, potentially marking the largest gain in six months. Over the past 12 months, durables are expected to move back into the black, up 0.1% following two consecutive months of decline.

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Also on Thursday, we’ll take a look at pending home sales and the February Kansas City Fed Manufacturing Index

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We’ll wrap up the week, on Friday with another key report, looking at January personal income and consumption, along with the latest read on the PCE – the Fed’s preferred inflation gauge.

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Personal consumption is expected to rise 0.3% in January and 5.9% on an annual basis, a potential uptick from the 5.7% annual gain in December, and still within the average established since June 2023. Income, meanwhile, is expected to rise 0.3% in January and 4.2% year-over-year, down from the 5.3% annual gain in December, although still perpetuating an average pace of over 4% since the start of 2024.?

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On the inflation front, the PCE is expected to rise 0.3% in January, matching the increase the month prior, and 2.5% on an annual basis, potentially marking a one-tenth of a percentage point decline from the pace reported in December. Stripping out food and energy, the core PCE is expected to rise 0.3% in January, a potential uptick from a more muted 0.2% gain the month prior, and 2.6% year-over-year, potentially marking a two-tenths of a percentage point decline from the pace reported in December and the smallest annual gain since June. A welcome step in the right direction following a disappointing headline rise in both the January read of the CPI and the PPI.

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Also on Friday, the February Chicago PMI Index will be released.

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-Lindsey Piegza, Ph.D., Chief Economist