Wholesale Prices Show Signs of Inflation

Wholesale prices experienced a significant jump last month, indicating that the Federal Reserve's battle against inflation may not be over. As a result, the central bank may be forced to postpone interest rate cuts.

According to data released on Friday by the Bureau of Labor Statistics, the Producer Price Index for final demand increased by 0.3% in January. This marks the fastest pace seen in the past five months and is notably higher than the 0.1% predicted by economists surveyed by FactSet. While this news unfolded, the S&P 500 remained relatively unchanged during morning trading on Friday.

Although goods costs decreased by 0.2% in the previous month, it is important to note that services were the driving force behind this notable increase. The index for final demand services rose by 0.6% in January, representing the largest increase since July 2023. This surge was primarily fueled by higher prices in various service sectors such as healthcare, professional services, financial services, and entertainment. Financial services and healthcare experienced significant price hikes, while hotel rates also witnessed a sharp rise.

These developments bring bad news for Fed officials who had expressed a desire to observe a more widespread disinflation in the U.S. economy, particularly within the services sector, before considering interest rate cuts. The recent inflation data suggests that the Federal Reserve's cautious approach to easing monetary policy was justified.

PNC Senior Economist Kurt Rankin emphasized that it is crucial not to draw broad conclusions from a single month of data; however, ongoing wage pressures and consistent consumer demand in the services sector at least indicate that the PPI bounce in January 2024 should not be dismissed as an isolated incident.

The Producer Price Index data is closely monitored due to its contribution to calculating the Fed's preferred inflation gauge, known as the personal-consumption expenditures price index. This data is expected to be released on Feb. 29. After strong PPI and CPI reports, Citi's chief U.S. economist Andrew Hollenhorst predicts that the core PCE, which excludes the typically volatile food and energy prices, will rise to 0.4% on a monthly basis. This represents an increase from the 0.2% rate seen in December.

Similarly, Bank of America economists Stephen Juneau and Michael Gapen estimate that January core PCE inflation reached 0.4%. Although January data can be noisy, these economists argue that the inflation data suggests a setback in disinflation during this period.

Introduction

The much-anticipated "supercore" PCE inflation, which accounts for services excluding energy and housing, is expected to reach a significant 0.55% pace in January. This reading, if accurate, would be the highest since March 2022 and could serve as a warning indicator for the persistent stickiness of services inflation.

Troubling Sign for Fed Officials

If core PCE was 0.4% last month, it would mean that the six-month annualized PCE reading would rise to 2.4%, surpassing the previous rate of 1.9%. This further increase alarms Fed officials and highlights the potential challenges they may face.

One-Off Price Hikes Influence Data

Similar to the Consumer Price Index data released earlier this week, Santander’s chief economist, Stephen Stanley, clarifies that the increases reflected in Friday’s PPI report are partly due to one-off price hikes at the beginning of the year. It’s worth noting that a similar pattern occurred last year when core inflation slowed towards the end of 2022 but experienced a significant jump of 0.4% in January 2023. This demonstrates the need for caution in interpreting short-term fluctuations in inflation.

Fed Officials Remain Vigilant

Fed governor Christopher Waller emphasized the potential impact of annual revisions and start-of-the-year noise in the data, acknowledging the need for a thorough analysis beyond temporary fluctuations. Although the January inflation rate is unlikely to persist going forward, there is concern that businesses currently possess significant pricing power, disrupting the previously benign core inflation trend.

Implications and Rate Cut Decision

With Fed officials already skeptical about sustainable inflation on track towards a 2% target, the January inflation data may delay rate cut decisions by a few months. According to Stanley, central bank policymakers are likely to maintain their current stance for most of the year. This anticipation of a prolonged hold on rates may catch some off guard.

In summary, these warning signs indicate the potential challenges the Fed may face in managing inflation. While temporary factors must be considered, the sustained increase in prices warrants a cautious outlook.