CPI Comes in Warm but Remains on Path to 2-Percent Target as Broader Economic Activity Slows

Key Takeaways:

• The Consumer Price Index (CPI) increased 0.3 percent in December and was up 3.4 percent compared to a year ago, accelerations of two-tenths and three-tenths compared to November, respectively, according to the Bureau of Labor Statistics (BLS). Energy prices, which had fallen for two consecutive months, rose 0.4 percent, while food prices increased 0.2 percent. Excluding food and energy, core prices rose 0.3 percent for a second consecutive month and were up 3.9 percent compared to a year earlier. Core inflation remains elevated due in large part to shelter costs, which increased 0.5 percent over the month, the fastest gain since September, medical care services, which rose 0.7 percent, and a surprising 0.5 percent increase in used car and truck prices.
• The Producer Price Index (PPI) declined 0.1 percent in December, its third consecutive negative print, according to the BLS. Compared to a year ago, prices were up 1.0 percent. Excluding food, energy, and trade services, the core PPI rose 0.2 percent over the month and 2.5 percent compared to a year prior.
• The ISM Services Index declined 2.1 points to 50.6 in December, its lowest level since May. Of note was a 7.4-point drop in the employment index, which fell to 43.3, its lowest level since the onset of the pandemic and its first time below the expansionary threshold of 50 since May. The business activity index moved up 1.5 points to 56.6, while the new orders index declined 2.7 points to 52.8.
• Consumer (non-mortgage) credit outstanding increased by $23.8 billion in November following a month of just $5.8 billion growth in October, according to the Federal Reserve. Revolving credit (largely credit cards) increased by $19.1 billion, while nonrevolving credit (largely student and auto loans) rose by $4.6 billion.
• The National Federation of Independent Business (NFIB) Small Business Optimism Index increased 1.3 points to 91.9 in December, its highest level since July. On net, negative 36 percent of firms expect the economy to improve and negative 4 percent of firms expect real sales to be higher in the next six months, improvements of 6 percentage points and 4 percentage points, respectively, compared to November. Negative 8 percent of firms on net expect credit conditions to ease, an improvement of 3 percentage points. A plurality of 23 percent of firms reported inflation as their single most important problem, an increase of 1 percentage point compared to November.
• The real goods U.S. trade deficit narrowed by $2.3 billion in November, according to the Census Bureau. Real exports declined 2.3 percent, while real imports were down 2.5 percent.

Forecast Impact:

The December CPI report was in line with our expectations. While core inflation was hot for a second straight month, the underlying details were less worrisome. Lagged shelter costs, which we believe will decline over time as newly signed leases showing slower rent growth flow into the CPI measure, contributed 2.7 percentage points to the 3.9 percent annual growth rate. Additionally, the Fed’s preferred PCE measure of inflation, which captures a more holistic view of medical care costs, such as those that are paid on behalf of consumers, will likely not show the same jump in healthcare prices that the CPI version does. Combined with ongoing signs of cooling in producer prices, the CPI report had minimal impact on our view that inflation will continue to trend toward the Fed’s 2-percent target over the course of 2024.

The decline in the ISM services index points to slower growth heading into 2024, in line with our expectations. Additionally, the significant decline in the employment portion of the index adds to mixed evidence that suggests the labor market may be softening. Finally, the decline in both real exports and imports also points to slower growth domestically and abroad, also supportive of our forecast for weaker economic growth in 2024.

Nathaniel Drake
Economic and Strategic Research Group
January 12, 2024

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