Truflation US Inflation Update  February 2024

Executive Summary 

The US economy is booming. The Q4 GDP growth estimate saw a marginal downward revision to 3.2%, but the composition of US GDP is stronger given the fact that the revisions reflect inventory investment, upgrades to consumer spending, and government investment. In addition, the Q1 GDP outlook remains strong, with growth expected to continue. This will largely be driven by retail sales, which are set to receive a boost from tax refunds and weather-related factors. 

The US economy has added 275,000 new jobs, while the unemployment rate increased 0.2% percentage points to 3.9%. This, coupled with wage growth continuing to outstrip inflation (albeit at a marginally cooler rate than previous months) still bodes well for a strong economic outlook.

Although inflation has cooled, the CPI and PCE price indexes reflect a continued stickiness over the past several months, including January. The CPI dropped to 3.1% in January, while the Core CPI remained unchanged at 3.9%. There are indications that we could be in a stagflation environment, similar to that of the 1970’s. As for February, the markets are predicting that CPI-U will come in between 2.7% and 3.2%, while Truflation is expecting CPI at 2.9%.

The key highlights from February’s Inflation Report are:

• Goods prices have continued to drop significantly, driven primarily by vehicle purchases (new and used), recreation and culture and medicines, while services are experiencing a milder reduction.
• Housing prices are on the rise again, especially in the owned category. With mortgage rates increasing again and continued supply shortages, the housing affordability crisis persists.
• Transportation costs, particularly petrol prices, are on the rise again due to increasing oil commodities prices.

Overall, we question the need for the Federal Reserve to cut interest rates to drive economic growth when the US economy is already so strong. Markets are seeing a stellar start to the year, and the labor market remains tight. As such, an interest rate cut in March is very unlikely. Should this trend continue, we are expecting the first rate cut to come in the middle of the year. 

Are we seeing the start of stagflation?

Recent signs of stickier inflation in the US have increased concerns that investors are perhaps too optimistic about the odds of a soft landing. The January PCE price index reading was in line with market expectations, while the CPI inflation figure came in hotter than expected. This highlights that the path to the 2% Federal Reserve inflation target is not going to be as smooth as hoped.

The major concern is that inflation could enter into an era of stagflation, where price increases re-accelerate while economic growth slows. Given the strength of the markets and the economy in Q4, it may be that investors are underestimating this risk for 2024, especially given the similarities between the path of the CPI in the 1970s and what we are seeing today.

Graph 1 – CPI-U Year-over-Year Percentage Change 1966 to 1982, and 2013 to present.

Source: US Bureau of Labor Statistics 

The inflation story in the 1970s and 1980s was driven by an oil embargo and a war in the Middle East, while the Vietnam War also contributed to the rising prices. These impacts were similar to the price trends we are seeing now, given the impact of COVID, the wars in Ukraine and Israel, and the supply-chain issues we have seen over recent years. In addition, US government spending remains a key concern.

Indeed, we are now seeing significant price increases in cocoa which will significantly impact the prices of food. On top of this, oil prices have passed $80 a barrel once again for the first time since November. Higher oil prices were one of the key contributing factors that drove a return of inflation at the end of the 1970s.

One of the risks for markets, in particular for equities, is that the Fed won’t cut rates as quickly as the market expects. Economists have argued that inflation is coming down and the Fed’s fight against inflation is working. However, the key concern is the strength of the US economy. 

Recently, the Q4 estimate of economic growth was lowered marginally to 3.2% from 3.3%. However, the GDP composition is much stronger now given the fact that the slight downward revision is a reflection of the inventory investment, upgrades to consumer spending, residential and business outlays, and state and local government investment. 

In 2023, the economy grew 2.5%, marking an acceleration from 1.9% in 2022. This means the economy is growing above what Fed officials regard as non-inflationary growth of 1.8%.

The economy continues to defy a recession after the US Central Bank aggressively raised interest rates to curb inflation, primarily thanks to the tight labor market. In February, non-farm payrolls rose by 275,000, beating estimates of 200,000. However, the unemployment rate unexpectedly increased 0.2 percentage points to 3.9%, also above consensus estimates.

Employment numbers continue to trend upward in health care, government, food services, and drinking establishments, social assistance, and in transportation and warehousing. Status on job vacancies fell by 26,000 to 8.863 million in January, while the number of quits dropped to a three-year low.  There were 1.45 jobs for every unemployed person in January which is up from 1.42 in December, indicating that the labor market remains strong.  This is well above the average of 1.2 during the year prior to the pandemic (2019). 

On top of this, wage growth continued to outstrip inflation for the seventh month in a row, having risen to 5.7% in January. As such, it is not surprising to see that households have been able to marginally improve their savings rate by 0.1 percentage points to 3.8%.  

Retail sales can also be expected to experience a boost, given the weather-related rebound in February combined with a recent surge in tax refunds. The Federal Reserve Bank of Atlanta's GDPNow model is projecting that the Q1 GDP reading will come in at 2.1%, marking another strong quarter of economic growth. 

Consumer spending, which accounts for more than two-thirds of US economic activity, increased at a rate of 3%, adding two percentage points to the Q1 GDP growth. Previously, it was estimated at 2.8%. This stronger consumer spending, coupled with the upgrade to investment in homebuilding and business outlay (such as factories), means domestic demand was stronger than initially thought.

Recent Inflation Trends

Inflation has certainly been cooling and is no longer running wild, but the rate of decrease is now slowing down. Both the BLS-issued CPI and the Personal Consumption Expenditures (PCE) price index have reflected continued sticky inflation for several months and the January reports were no different. 

The headline CPI increased 0.3% month-over-month (MoM) in January after rising 0.2% in December. Over the last 12 months, the headline CPI increased 3.1%. Core CPI (which excludes volatile food and energy prices) rose 0.4% MoM in January and 3.9% year-over-year (YoY), the same as in December. 

Meanwhile, the headline PCE price index also increased 0.3% MoM in January, while the annual PCE inflation rate fell from 2.6% in December to 2.4% in January. The PCE Core index rose 0.4% MoM in January, accelerating from 0.1% in December. The YoY number sat at 2.8% in January, compared to 2.9% in December.   According to both measurements – the PCE and the CPI – core inflation remains very sticky, driven to a large extent by higher housing costs. 

Graph 2 – US Inflation Gauges - PCE vs CPI Core and Headline Inflation

Source: Bureau of Labor Statistics and Bureau of Economic Analysis

This stickiness of inflation, which has already led financial markets to push back rate cut expectations from May to June, has been attributed to price rises at the beginning of the year. In February, the market expects the BLS to report a headline CPI number in the range between 2.7% to 3.2%. Truflation is expecting February’s CPI (as reported by the BLS) to come in at 2.9%.

Despite the marginal uptick in the prices of goods, particularly food and alcohol, we see this as a marginal recovery following the January price dips that followed the festive season. However, services remain more stubborn and have seen continued price rises in February, driven by strong wage growth and plentiful employment opportunities. This rising cost of services, which includes healthcare, restaurants, hotels, and recreation, is now at the heart of the US Central Bank’s fight against inflation. Given the continued inflationary pressures in this category, policymakers have said they are in no rush to start lowering borrowing costs. 

Graph 3 – Truflation Core Inflation Measures (Core, Goods vs Services)

The fact that core inflation has remained sticky in January does provide key focus areas that must be addressed to bring inflation down to the Central Bank’s 2% target.  Given the substantial weighting of the services sector (making up 42%) and food in the US CPI index, we still believe an economic slowdown will be required to address the structural inflationary pressures and bring down inflation to the Fed’s 2% target. In particular, we need to see further softening in the labor market for prices in the services sector to cool.

With income outpacing spending, February’s savings rate rose marginally to 3.9% from 3.8% in January, but remains well below the average. Consumer spending will continue to gradually increase over the course of 2024, although at a slower pace than in 2023, as job and wage gains soften. As such, economic expansion should also continue throughout this year and into the next.

Graph 4 – US Personal Consumption

Source: Bureau of Economic Analysis, Personal Income and Outlays Report

However, we are beginning to see consumer confidence falter. In February, Truflation’s Consumer Sentiment Index saw a marginal drop from 95.91 to 93.77, after three months of significant gains, reflecting the uncertainty about the labor market, especially given recent layoff announcements combined with the political environment. We are seeing this decrease in confidence across all income groups, except those earning $150k and above.  

Despite this drop in confidence, though, the index still reflects a 5% improvement in confidence versus last year. But looking at consumer expectations, we are seeing a renewed pessimism regarding future business and labor market conditions. If this continues, we’re likely to see a drop in demand for big-ticket items, whether it is a car, home, appliances, or holidays. 

Graph 5 – Truflation Consumer Confidence Trends

This mild setback in consumer confidence has implications for Truflation’s inflation outlook. It is clear that as supply concerns have alleviated, price spikes have also begun to unwind. Now, inflation is primarily driven by future consumer spending/demand combined with potential geopolitical risks.

With this in mind, the most significant upward contributions to inflation in February came from petrol, food, housing, and electricity, with alcohol & tobacco, vehicle purchases, and household durables once again the biggest downward contributors.

Categories applying continued upward pressure on inflation

February registered upward inflationary pressures mainly coming from petrol, food, utilities, and housing. These have been driven by rising supply pressures given the geopolitical environment on the one hand, and a tight labor market driving up the services element on the other.

Petrol prices reversed their previous downward trend to become the single biggest contributor to inflation on the upside with a 3.83% MoM rise in February. This, as expected, has been driven by the reversal of Crude Oil prices, which have been gradually increasing since the middle of December and reached $79.09 per barrel on March 7, 2024. But despite this, the category is still experiencing annual deflation of -5.61% YoY. 

Graph 6: Price of WTI Crude Oil per Barrel

US$79.09 for March 7, 2024

Data Source: Weekly Petroleum Status from the Energy Information Administration

US Commercial Crude stockpiles rose by 1.4 million barrels last week, according to the Energy Information Administration (EIA). The inventory build-up is down substantially from prior weeks as refineries process more crude into finished products. However, US gasoline stockpiles fell by 4.5 million barrels during the same period, suggesting demand for gas is picking up. 

The outlook for oil prices remains uncertain, with OPEC+ countries slashing production and geopolitical tensions simmering in the Middle East. In addition, when the Fed reduces interest rates, this will likely stimulate demand once again, resulting in a rise in oil prices.

Food has registered a resurgence of inflation, with prices rising by 0.7% MoM and 0.6% YoY.  This upward trend is prevalent in both the grocery retailing prices (food at home) and the prices of food away from home.  

Graph 7: Truflation Food & Beverage Category Price Trends

Consumers have been increasingly pushing back against food price increases by changing the way they shop, which has brought down inflation. For example, they are increasingly choosing store-brand products over well-known name brands, switching to discount stores, or simply spending less on snacks and gourmet foods.

Food companies have responded to this consumer pushback by increasing prices more slowly compared to the peak we saw three years ago. This doesn’t mean that grocery prices will fall back to the levels seen during that period, though prices for some items, including eggs, apples, and milk, are already below their respective peaks. Overall, the milder increases in food prices have helped to cool food inflation and have contributed to a lower overall inflation number.

Manufacturers have also been streamlining costs. For example, Unilever – the producer of items like Hellman’s mayonnaise, Ben & Jerry's ice cream, and Dove soaps – increased prices by an average of 13.3% in 2022, while sales volumes fell by 3.6%. In contrast, in 2023 Unilever raised prices by only 2.8%, while the year saw sales volumes rise by 1.8%. Other businesses like General Mills and PepsiCo have also noticed the shift in consumer behavior, so they, too, are reining in their price increases and focusing on boosting sales.

As consumers are increasingly seeking bargains, retailers have also been offering promotions and discounts. January 2024 saw an increase in the number of discounts to address rising inventory levels and to rekindle consumer demand for regularly purchased items. In February, many of these discounts came to an end, and this alone has led to a gradual increase in prices. 

Prices for food away from home are also continuing to increase but at a significantly lower pace. Prices in this category are up 0.66% MoM, while annual growth has fallen marginally to 2.04%. For example, McDonald’s reports that consumers with incomes below $45,000 are visiting less and spending less when they do visit, choosing to spend on lower-priced items. 

Mary Daly, president of the Federal Reserve Bank of San Francisco, said that the firms she has spoken to have witnessed a marked increase in price sensitivity, with consumers reluctant to make purchases unless they are seeing a 10% discount.   

As a result, companies across all industries expect to impose smaller price increases this year, according to surveys by the Fed's Regional Banks. The New York Fed, for instance, says companies in its region plan to raise prices by an average of about 3% this year, down from about 5% in 2023 and as much as 7%-9% in 2022. In short, it appears companies are well on their way to reducing price hikes.

In February, the utilities category saw an increase of 1.1% MoM and 0.06% YoY. This increase was driven by electricity, where prices rose 1.12% MoM and 0.34% YoY. Given that average temperatures in the US in January and February have been lower than in previous years, we have seen an uptick in usage that has driven up the cost of bills.   

In addition to this, the EIA expects that the recent drop in wholesale power costs will likely trickle down to the prices consumers pay on their power bills later in 2024. 

Graph 8: Truflation Utilities Category Price Trends

Finally, housing, the last major contributor to upward inflation, saw a 0.58% MoM increase in February, while annual inflation held steady at 3.86%. The category as a whole has seen mixed results, with the prices of rented lodgings remaining flat on a monthly basis but seeing a marginal uptick on an annual basis: from 1.09% YoY in January to 1.55% YoY in February. 

It is, however, the owned housing segment that was the real culprit in driving up prices in February. Here, price growth accelerated from the previous month – from 0.55% MoM in January to 0.88% MoM in February. Annual inflation in this category has hit 5.62%.

National average 30-year mortgage rates have marginally increased to 6.94% as of February 29, 2024, compared to 6.63% at the end of January, according to Freddie Mac. Towards the end of last year, the Fed announced that interest rate cuts were on the table for 2024, which led to a significant drop in mortgage rates towards the 6% range in January. 

However, since early February, mortgage rates have climbed back up in response to strong economic data, which is highly likely to result in the Fed holding interest rates in the March meeting. This might mean consumers will be less likely to purchase homes in the current climate, adopting a “wait-and-see” approach instead.

The most recent data shows that new residential home sales rose 1.85% YoY in January, while existing home sales remained flat compared to the same month a year ago, according to the Census Bureau and the National Association of Realtors (NAR). In addition, the median prices of existing home sales rose 3.75% in January.  

Graph 9: Truflation Housing Category Price Trends

While existing home sales are considerably lower than they were a couple of years ago, January has seen an uptick, with buyers potentially looking to take advantage of lower mortgage rates. Housing inventory at the end of January stood at 1.01 million units, up 2% from December and 3.1% from a year ago. 

However, at the current sales pace, the unsold inventory sits at a three-month supply – marginally lower than the 3.1-month supply in December. This remains a key concern since inventory must reach 4-6 months of supply to ease the rise in housing prices, so it is currently moving in the wrong direction.

Additionally, new residential construction levels remain significantly below historic averages, especially if we consider the population growth in the US since 1999. The number of new residential home permits that are yet to begin construction started the year at -1.7% MoM, while new residential starts were down -8.8% MoM and new residential completions were at -10% MoM. This suggests the chances of the inventory problem being resolved any time soon are low.

Graph 10: Housing Supply: New Residential Permits, Starts and Completes in 000s of Units

Source: US Census Bureau / New Residential Construction Report (all in 000s of Units)

Against this backdrop, it is not particularly surprising to see house price growth accelerating from 0.55% MoM in December to 0.88% MoM in January. In particular, we are seeing a 3.75% YoY increase for existing home sales, which account for roughly 80% of total home sales. The high mortgage rates and home prices, coupled with historically low housing stock, continue to put homeownership out of reach for many – most notably first-time buyers who remain more pessimistic than ever about being able to afford a home.

We do not expect inventory levels to increase particularly soon, while a rapid fall in mortgage rates is also unlikely to come as soon as anticipated. As such, we expect owned home prices to remain high for the interim. Even once the Fed reduces rates, who is to say that pumped-up demand will not drive sales and prices up again, wiping out any inventory gains? A measured approach is needed to reduce this impact and address the structural issues in the US economy. 

Categories applying downward pressure on prices

In February, the four main categories that contributed to the downward inflation trend were vehicle purchases, alcohol, household durables, and recreation and culture, mostly reflecting the continued price drops in the goods categories (which make up just over half of the Truflation CPI index).

The transportation category as a whole has been a mixed bag, with petrol prices seeing a significant increase. However, vehicle purchases (new and used) are continuing to apply downward pricing pressure, with inflation in this category sitting at -0.31% MoM and -5.75% YoY.  

Graph 11: Truflation Transportation Category Price Trends

The good news is that there seems to be some light at the end of the tunnel for this category, with the monthly rate of price declines slowing significantly. However, demand for new and used cars has remained sluggish in the last couple of months, while inventory levels continue to increase.   

Graph 12: Motor Vehicle and Parts Dealers in $ Millions: Adjusted Sales and Inventories

Source: US Census Department: Advance Monthly Retail Trade Survey

This anemic demand, along with high financing interest rates and excess inventory, has continued to place downward pressure on vehicle prices. As inventory levels outstrip demand, we expect prices in this category to continue falling in the short term. 

Alcohol prices were down -0.60% MoM in February, but up +1.43% YoY. The drop was driven by the return to normal purchasing behaviors after the holiday season, as well as people adopting new diets at the start of the year. 

The other two categories contributing to the downward movement in inflation were household durables and daily use items and recreation and culture, which have seen a 0.06% and 0.17% MoM increase in prices, respectively. While this is still an upward trend, inflation in these two categories is significantly lower than in the wider market. The annualized growth rates have dropped to 3.09% and 2.01%, respectively. This has also been affected by consumers’ reluctance to spend full prices or purchase high-ticket items, which is leading to increased discounting activity from retailers.

So what does this mean for inflation in 2024?

The US economy started 2024 strong, with the labor market, consumer confidence, and inflation moving in the right direction. However, rising consumer debt and elevated interest rates are set to affect economic growth, particularly when it comes to spending. Based on the current market information, we expect spending to remain strong but its growth rate to cool, while GDP growth will also likely slow down. 

Consumer spending held up nicely in 2023, despite inflation and higher interest rates, but, in our view, this trend is unlikely to hold. Real disposable personal income growth struggled to outpace real consumer spending in H2 2023. On top of this, savings are dwindling and household debt is rising (along with delinquencies). The growing ‘buy now, pay later’ trend will also no doubt weigh on future spending as bills come due. Thus, overall consumer spending growth will gradually slow until households find a new equilibrium between income, debt, savings and spending in Q3 2024.  

Labor conditions have been remarkably persistent over the last year and we expect this to continue in the coming quarter. However, we do anticipate some softening – but not unraveling – of the labor market as the economy slows. This ongoing tightness is, in part, a reflection of a shrinking labor force as baby boomers retire, making businesses resistant to laying off workers. This, coupled with the easing of interest rates and inflation at the back end of the year, can be expected to lead to an expansion of consumption in late 2024.

Government spending was a positive contributor to growth in 2023 due to federal non-defense spending associated with infrastructure investment legislation passed in 2021 and 2022. However, growth is likely to slow in 2024 and 2025 as infrastructure spend-out stabilizes. Furthermore, political volatility surrounding fiscal policy, debt, and outlays could impact government spending over the next few years.

The net impact on inflation is that we will likely see continued progress over the coming quarters. However, in February, Truflation is expecting the headline CPI to come in at 2.9%, with the annualized rate for Q1 remaining at 2.7%. Forecasters are expecting an inflation rate of 2.5% YoY for the current quarter, down from their previous prediction of 2.8% YoY.  

The consumer-based inflation expectations surveys from the University of Michigan and the Federal Reserve Bank of New York, which represent the sentiment of American households, reveal that consumers expect inflation to come down on a one-year horizon, but they are not as optimistic as the institutions.

Graph 13: Consumer Inflation Expectations (2% is the Fed Target)

 Source: Federal Reserve Bank of New York & University of Michigan

Uncertainty around the future direction of oil prices is the major contributor to this sticky inflation. At present, we are seeing oil prices increasing due to higher demand and geopolitical factors. The supply restrictions applied by OPEC+ countries are less likely to have an impact, given the more productive wells that spur US crude oil production. US crude oil production has increased to record highs since 2010 and has risen even more quickly in recent months.

We also expect demand for services to cool as consumer spending wanes and the upward wage inflation gradually calms down.  

In housing, the persistent demand for homes and a dearth of supply will continue to be a driver of upward price pressures. Looking ahead, we do not expect new supply from residential investment growth to meaningfully improve until interest rates start to fall. Even once this occurs, we could easily see an acceleration in prices as pent-up demand could flood the market.   

Based on all of this and the current data, we do not expect the Central Bank to begin reversing its most aggressive tightening campaign in decades until the middle of this year, at which point the Fed will likely have greater confidence that inflation is under control. Policymakers will need to address the long-term structural elements to get to this point.  In addition, the extent of rate cuts is likely to be gradual – we anticipate a 25 basis point reduction three or four times this year, equating to a maximum of 100 basis points in total. 

About Truflation

Truflation provides a set of independent inflation indexes drawing on 30+ data partners/sources and more than 14 million product prices across the US. These indexes are released daily, making it one of the most up-to-date and comprehensive inflation measurement tools in the world. Truflation has been leveraging this measurement tool to predict the BLS CPI number, with four predictions spot on and all but one deviating by no more than 20 basis points since coverage was initiated.

APPENDIX A

Truflation Category Percentage Change Data

Month-over-Month and Year-over-Year

All Data is based on February 2024