February CPI report: Calm before the storm

Consumer price inflation in February came in as expected, with the annual headline rate remaining steady at 2.4%. Core inflation, which excludes food and energy, rose 2.5% on an annual basis, unchanged from last month’s reading. The underlying dynamics are consistent with recent periods: services inflation is sticky but not worsening, and goods inflation is mostly contained.

Nevertheless, while today’s report is reassuring, the market’s focus has already shifted. The surge in energy prices brought on by the Iranian conflict suggests spillover risks to broader inflation in the months ahead, particularly if the conflict drags on.

• Headline inflation rose 0.2% from the prior month, as expected, keeping the annual rate steady at 2.4%. Core inflation, which excludes food and energy, rose 0.2%, also as expected, keeping the annual rate steady at 2.5%. Overall, the lack of an upward surprise in the February inflation report offers some reassurance that underlying inflation pressures have been trending in the right direction. Yet, amidst the Iran conflict, which is pushing energy prices higher, this report is already dated.
• The highly volatile energy category increased 0.6% in the month, driven by a notable rise in fuel oil amid the lingering effects of cold weather that blanketed much of the East Coast. Also, note that this is before the more recent sharp rise in oil prices. Meanwhile, food prices rebounded, with three of the six major grocery store food group indices increasing in February. While fruits & vegetables saw price increases, declines in meats, dairy, and cereals & bakery products blurred the potential impact from lingering tariff pass-through.
• Goods categories were only slightly higher during the month. Tariff-sensitive items continued to show upward price pressures, with apparel, household furnishings, and certain recreational commodities seeing price increases. Nevertheless, with no new tariffs implemented since September of last year, the effects of tariff pass-through should gradually diminish throughout this year.
• Core inflation remains largely driven by services prices, in particular shelter costs, which were the largest contributor to overall inflation. A major component, owner’s equivalent rent, has steadily decelerated over the past three years, consistent with the lagged methodology used in calculating this measure. Rent prices also posted the smallest one-month increase since January 2021. Meanwhile, medical care services inflation rebounded amid increases in nursing home and physician office prices, likely reflecting ongoing structural issues with labor supply and increased cost pass-through in this industry.
• The Fed’s preferred supercore inflation measure increased by 0.3% in the month, pushing the annual rate up to 2.8%. Amid the ongoing softening in labor demand, the supercore inflation measure, which excludes shelter from core services and is primarily driven by wage costs, has remained relatively anchored.

Today’s CPI report already feels dated, especially as the geopolitical backdrop has shifted significantly since the end of February. Crude oil prices are up roughly $30 in recent weeks, and investors are focused on how the conflict could feed into inflation in the months ahead. Indeed, attention now turns to how long energy prices stay elevated, the risk of second-round effects, and whether core inflation begins to worsen materially.

The Fed has historically looked through energy-driven price spikes. Yet, as inflation has sat above target for almost five years, it may be harder to do so this time. Our base case remains two rate cuts in the second half of the year, though that outlook would be at risk if energy prices remain high and the conflict drags on.