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Written by: Meera Pandit and Stephanie Aliaga
Headline inflation cooled in March, although core inflation held firm. Headline consumer price index (CPI) rose just 0.1% month/month (m/m) and 5.0% year/year (y/y), falling from 6.0% y/y last month due to favorable base effects and continued declines in energy. Core CPI rose 0.4% m/m and increased at a slightly faster pace of 5.6% y/y. Shelter was the largest contributor to overall inflation; without it, headline CPI would have declined by 0.2% m/m. Shelter increases have been stubbornly high due to lagged effects, but the Federal Reserve (Fed) is aware of this, so they have focused squarely on two key concerns: wage growth and core services ex-shelter, both of which are showing more progress than meets the eye.
After peaking in March 2022 at 5.9% y/y, average hourly earnings have declined to 4.2% y/y and have been eroded by higher consumer inflation for 24 consecutive months. Furthermore, not all workers have benefitted equally from higher wages, but all consumers are impacted by higher inflation, which has dampened consumer spending firepower. Recent data also point to further labor market cooling ahead. Small business owners surveyed by the NFIB note fewer plans to fill open positions or create new jobs over the next three months, and the share of firms reporting raising compensation has steadily fallen after peaking in January 2022.
Our estimate of core services ex-shelter CPI, which the Fed has honed in on over the last several months, fell to 5.9% y/y in March after running at an average of 6.4% y/y in the preceding 6 months.1 The lion’s share of this so-called “super core” inflation is attributable to transportation services. Of that, leased cars and trucks alone account for 1 percentage points of the y/y growth and motor vehicle insurance accounts for 1.5 percentage points. Both the vehicle repair business and auto insurance have been impacted by higher labor costs, and repair shops have incurred higher input costs, both of which have been passed on to consumers. Now that supply chains have normalized, allowing used vehicle prices to fall considerably and new vehicle prices to moderate, auto businesses may not need to raise prices at such an elevated pace and we anticipate these services prices will soon decline. The key point, though, is that much of the “stickiness” that has been ascribed to core services may largely reflect the lingering hangover of supply chain issues, where Fed policy has little impact.
While recent data continue to show a disinflationary trend, labor and inflation data may not be soft enough for the Fed. Therefore, the Fed may well opt for an additional 25 basis point rate hike at its May meeting in its steadfast pursuit to tame inflation, but that hike may be its last.
Contributors to core services CPI ex-shelter*
Contribution to y/y % change in custom CPI index, non seasonally adjusted
Source: Bureau of Labor Statistics, FactSet, J.P. Morgan Asset Management. Contributions mirror the BLS methodology on Table 7 of the CPI report. Core services ex-shelter CPI is a custom index using CPI components created by J.P. Morgan Asset Management. “Transportation services” primarily includes leased cars and trucks, motor vehicle insurance and motor vehicle maintenance and repair. Airline fares are shown separately from the rest of transportation services. Data are as of April 12, 2023.
1 Chair of the U.S. Fed, Jerome Powell, has explicitly quoted the PCE measure for core services ex-housing inflation, which we show on Page 30 of the Guide to the Markets. However, given the timeliness of the CPI data, we’ve constructed a custom CPI index on services excluding energy and shelter, shown in the chart.
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