Stephen Miller
The big fear leading into last night’s US February CPI release was that it might reinforce the notion that the US is headed for a version of ‘stagflation-lite’ where inflation proves “sticky” while growth subsides at potentially a fast enough rate to add to fears that the US economy slips into recession. That circumstance was thought to limit the Fed’s ability to manoeuvre should current indications of a slowing economy gather pace leading to greater dislocation in the labour market
In the end the inflation picture was not quite as bad as had been expected, let alone feared.
While the extent of the better news on the inflation front is probably insufficient to elicit a rate cut when the Fed’s FOMC meets next week, it certainly gives the Fed a little more “wiggle-room” to respond to adverse growth news at subsequent meetings.
That said, the much talked about “last-mile” challenges on inflation persist.
The better result largely reflected a fall in the price of airfares.
Certainly, it is clear that there has been little progress on inflation (indeed arguably there has been some deterioration) since the Fed commenced the easing process in September 2024 (see details section below). So the ‘stagflation-lite’ scenario remains plausible.
Maybe it was the ongoing concern on inflation that saw a somewhat underwhelming reaction from the bond market. Although to put in context the bond market has rallied strongly following the jolt it got from January’s adverse CPI picture.
Equity markets appeared to breathe a sigh of relief after being battered by emergent recession fears over the last couple of weeks but it was a far from convincing rally.
And in the broader scheme of things there is still a lot to worry about and I fear that episodic volatility may be a durable theme for equity markets in the months ahead.
Markets have already dramatically reassessed the likely consequences of the Trump Administration’s policies on financial markets.
Markets had been pricing a goldilocks scenario of declining inflation, declining interest rates and strongly performed equity markets.
That euphoria – reflected in richly priced risk markets – has reversed sharply. Meanwhile, rising bond yields in the immediate wake of Trump’s election have come off, although with inflation still exhibiting some “stickiness” there may be some limits on how far yields can fall. The Fed has expressed more caution about rate cuts compared to its tone in the latter part of 2024.
When Donald Trump became US President for a second time the prospects of a US recession in 2025 were small – but not non-trivial.
Less than two months into his term that risk seems to me better than even-money.
And were it to come to pass, the US authorities are less equipped to deal with a recession than they have been for some time.
To get some insight into how quickly things have turned, real GDP through 2023 and 2024 averaged 2.9 per cent and ranged between 1.6 per cent and 4.4 per cent. The current Atlanta Fed GDPNow estimate for current quarter GDP is -2.4 per cent. It won’t take that much to go from there to the popular definition of a recession (two successive negative quarters of GDP growth).
And even if the Fed may not be quite as constrained as feared, “sticky” inflation has robbed it of the flexibility to quickly cut rates. A flexibility the Fed enjoyed in the two decades or more leading up to the Pandemic. The structural quiescence of inflation that was a feature of that period has not only disappeared but reversed. Moreover, the Trump agenda when it comes to things like tariffs and immigration risk a negative supply shock that makes inflation “stickier” and growth more challenged.
And with a budget deficit approaching 7 per cent of GDP fiscal policy is close to maxed out.
The upshot is previously ebullient risk markets have needed to recalibrate.
Ominously, it seems Papa Bear Trump remains in hot pursuit of goldilocks!
US CPI: some details
The February consumer price index (CPI) report revealed a core inflation rate of 3.1 per cent. Measures of the “inflation pulse” indicate ongoing “stickiness” in inflation. The 3-month annualised core CPI was 3.6 per cent in February from 3.5 per cent in November and compares with a trough of 1.6 per cent in July 2024. The 3-month annualised Cleveland Fed trimmed-mean measure was 3.8 per cent in February from 3.4 per cent in November and a trough of 2.0 per cent in July 2024.
The February CPI does little to diminish some concern regarding the “stickiness” of services inflation. The 3-month annualised rate of services inflation (or “pulse”) was running at 4.5 per cent in February from 4.1 per cent in November, while the “services less rent-of-shelter” measure (a favoured focus of Chairman Powell) was running at 4.9 per cent from in February from 4.5 per cent in September.
Such detail will serve to reinforce Fed caution with respect to cutting the policy rate.
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