Inflation Cool Down in Progress: What’s Next?

The Bureau of Labour Statistics' most recent release of their Consumer Price Index (CPI) showed a 0.3% increase for December, up 3.4% over the year. CPI measures the average price change over time for a basket of goods and services consumers purchase. Monitoring inflation is crucial as the Fed evaluates the timing of interest rate cuts, decisions that will significantly impact mortgage rates.

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Prices rose 3.4% over the prior year, an increase from the 3.1% annual increase in the month before. However, Core CPI, which omits the prices of volatile goods and services such as food and energy, is at 3.9% year-over-year – the lowest since May 2021. Shelter inflation, which comprises more than 40% of Core CPI, further decreased to 6.2% over the year. Given that shelter prices are a significant driver of inflation, declines are a good indication of overall declines in inflation.

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Private indexes for shelter prices show an ongoing decline in shelter costs. Since shelter prices in the CPI capture new and existing renters, the Index tends to lag real-time market indexes tracking asking rent, such as Zillow or Apartment List. Real-time rent measures from Zillow and Apartment List preview future downward pressure on the CPI Shelter Index into 2024. As a result, shelter inflation is expected to drop later this year.

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Following the CPI release earlier this month, industry experts are watching for the upcoming Personal Consumption Expenditures (PCE) Price index data that is scheduled to be released this Friday. The PCE is the Federal Reserve's preferred measure of inflation, generally cited within its rate-setting policy.

The Fed must balance its timing of cuts with inflation data. Rate cuts influence treasury yields and wider market expectations - which, in return, influence mortgage rates and housing affordability. If the PCE continues to cool significantly, we can expect the Fed to remain on target and start cutting rates in March. If not, rates could remain high(er) for longer.

Plotify's Takeaway:

- December Core CPI rose 3.9% year-over-year, continuing a downward trend.

- Shelter inflation, which accounts for a large part of overall CPI, dropped to 6.2% year-over-year.

- The Fed will continue to monitor inflation data, including the PCE, in future rate-setting policy.

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