Note to readers: Here's the link to IBD's report on February CPI data released on Tuesday.
The stakes are high for Tuesday's Consumer Price Index data and Thursday's producer price index. After January's scorching inflation data, even moderately hot data for February could lead the Federal Reserve to revise its 2024 inflation target higher in next week's quarterly projections.
If that happens, December's forecast of three quarter-point Fed rate cuts also would be in jeopardy, which could take some steam out of the S&P 500 rally.
Keep in mind that both CPI and PPI data feed into the Fed's primary inflation rate, the core PCE price index. While the Fed's favorite measure won't get updated until the week after the March 20 Fed meeting, this week's data will give economists a good idea how hot PCE inflation will run.
CPI Inflation Forecast
Economists expect the headline CPI to rise 0.4% on the month, amid a rebound in energy prices. That would leave the 12-month CPI inflation rate at 3.1%.
Core prices, which exclude food and energy, are seen rising a more moderate 0.3%, following January's 0.4% increase. That would lower the core inflation rate to 3.7% from 3.9%.
Deutsche Bank economists expect core goods prices, which fell 0.3% in January, to be firmer in February. Apparel and medical care commodities prices may bounce after sharp declines to start the year. Declines in used car prices also should slow.
If goods prices don't fall as much, an in-line core CPI reading will require tamer services inflation. That's what economists expect, after price increases to start the year.
However, Nomura economist Aichi Amemiya noted that "industry data on hotel room prices point to another strong increase" in lodging-away-from-home costs. His firm also expects an increase in airfares, contributing to a 0.37% monthly rise in the core CPI.
PPI Impact On Fed Policy
While much of the PCE data matches up with Consumer Price Index data, several key inputs to the PCE price index come from the PPI. The three big ones are portfolio management fees, health care services and airline passenger services.
Portfolio management fees, which tend to follow stock prices with a bit of a lag, jumped 5.5% in January. Although portfolio management only makes up 1.5% of core spending, that 5.5% jump added eight-tenths of a percentage point to the core PCE price increase for January.
In January, airline passenger services prices slipped 0.5% vs. the CPI's 1.4% rise in airline fares. Yet it's possible that the PPI measure could rise faster than the CPI measure for February.
CPI Vs. PCE Health Care Inflation
The way health care inflation is measured is one of the biggest differences between the CPI and PCE price index, and among the reasons the Fed prefers the latter.
CPI data is based on out-of-pocket spending, while PPI data also includes employer and government reimbursements to medical providers. That means health care is a much bigger factor in the PCE, accounting for 18% of core PCE spending vs. an 8% weighting in the core CPI.
The good news is that the PCE measure of health care inflation has been much tamer than the CPI data lately. That trend didn't really carry through to January, but we'll find out if that was just a one-month blip.
Fed Inflation Forecast
Based on Nomura's estimates for the February CPI and PPI, the economists currently expect a 0.32% monthly increase in the core PCE price index, down from 0.42% in January.
If accurate, the core PCE price index would have to average just 0.17% per month over the next 10 months to match the 2.4% Federal Reserve projection.
"It is early in the year; however, if our forecast materializes, the FOMC may consider revising up their year-end inflation expectations," Amemiya wrote.
Already, it appears likely that the Fed will revise up its 2024 GDP growth projection of 1.4%. If its core PCE inflation projection moves up also, it's hard to imagine that the Fed would keep rate-cut guidance intact. That's especially the case because the Fed has subtly signaled concern about fueling the AI stock rally with rate cuts.
Fed Rate-Cut Odds
As of Monday morning, markets are pricing in 25% odds of a Federal Reserve rate cut at the May 1 meeting. Odds of a rate cut by the June 12 meeting stand at 70%. For 2024, markets are pricing in a year-end Fed funds rate of 4.46%. That implies markets see a slightly greater chance of four quarter-point rate cuts than three cuts.
S&P 500
The S&P 500 dipped 0.4% in Monday morning stock market action. On Friday, the S&P 500 touched an record high, before reversing lower to close off 0.65%.
Be sure to read IBD's The Big Picture column after each trading day to get the latest on the prevailing stock market trend and what it means for your trading decisions.
