E-piphany

It’s going to be hard to get too jazzed about today’s CPI report. Because it is entirely a pre-Iran-war number, it won’t have any of the energy spike that will make next month’s figure so exciting/alarming. Now, ordinarily I’d say that this will be the last ‘clean’ number without those influences, but this number isn’t in any sense clean because there are still echoes of the shutdown in it. Still, the fun part of those echoes will be in April’s number when the rent figures will have a one month spike as the October OER sample (all zeroes by assumption) drops out of the calculation. And that month will have Iran in it also. So buckle up for the next couple of months.

For February’s figure, though, the expectations were for +0.26% on headline inflation and +0.24% on core. Right around 3%, and not representing a return to the Fed’s target, but not too far off – except for the fact that it looked like they were on the upswing even before the Iran thing. Will anyone care?

Now, the US CPI swaps curve does have the influence of the war in it. But I present it here because it’s interesting. It isn’t surprising that it is inverted, with the near-term inflation higher due to energy, but the long end lower? That looks odd. But I’ll circle back to this later as it is actually a good reminder.

Also interesting, by the way, is the following chart of 5-year inflation swaps in several theaters. It is interesting that despite the wild ride in energy, US 5y CPI swaps haven’t moved very much – and certainly less than elsewhere. That’s partly because the US is less sensitive to oil prices than some other economies but also because the dollar has tended to be positively correlated with oil prices, dampening the direct pass through. It still looks like a lot to me, though. This is a 5-year tenor so also surprising that it moves that much with spot energy being the main source of volatility.

With those preliminaries, let’s look at the actual data.

The forecasts were pretty good: actual headline CPI was +0.267% while core was +0.216%.

The Apparel price spike is odd, but these happen from time to time and it’s a small category. The rise in Medical Care, which was mostly Hospital Services, was mildly discomfiting but on the other hand shelter was soft.

Core services and core goods both softened y/y. Core goods is at +1% y/y. The downward hook is expected, but the real question is whether it settles at +0.5% or -0.5%. I’m betting 0.5%. Still, it’s good news.

The singular surprise/miss was in Primary Rents. Owners’ Equivalent Rent was +0.22% m/m, about the same as last month and drifting lower y/y (although that will change in a couple of months when the OER sample rolls out the October zeroes). But Rent of Primary Residence was +0.13% m/m.

Clearly the trend is lower, but the sharp break (probably retraced somewhat next month) is quite surprising given the upward cost pressures on landlords. I suspect there are some big compositional changes here – rents possibly under pressure in big cities where reverse immigration flows are relieving pressure on the housing stock, and possibly some effect from NYC’s outmigration as well. I will have to dive into the details to see. But not right now.

Lodging Away from Home was +1%. This has been recovering from the dip last year but hotel prices are still below the post-COVID “gotta get away” highs. It’s a decent bet that we will see new highs here in 2026.

Airfares were also up, +1.4% m/m. Keep an eye on this. With energy prices going up, this is a fairly direct passthrough. Not this month, which is for February, but if jet fuel prices remain elevated then airfares will go up (and that ‘looks’ like core inflation even though it really isn’t).

The red dot is end-of-February numbers. But currently, Jet Fuel is at $3.49…it was at $4.11 just a couple of days ago. This will show up in airfares next month.

Let’s look at ‘supercore’, core services ex-shelter. Last month, supercore was +0.59% m/m; this month it’s “only” +0.35% m/m. Right now, on a y/y basis, Core Services ex-Rents is 2.94%, but that will jump next month as we are rolling off a very weak figure from last March. That’s when we had Airfares -5.27%, Lodging Away from Home -3.54%, and Car and Truck Rental -2.66%. That’s all dropping off, so next month we will see a rise in y/y supercore even if the m/m figures are soft. And they won’t be.

The distribution of price changes overall this month is interesting. There were a number of categories that rose less than 1% on an annualized m/m basis, but most of them not by very much. (The red text indicates the change is based on my estimate of the seasonality rather than the way the Cleveland Fed does this.)

There were also a lot of upper-tail categories, but the upper tails are longer. Of course, Median CPI (I don’t trust my estimate this month but I think it will be soft, probably less than 0.2%) doesn’t care how long the tails are. That’s the point of median.

So normally, median is comfortably above mean CPI because for a long time we have been in a disinflationary regime where tails were longer to the downside (aka negative skewness). This month that might not be true. I’ve written about this in the past: in inflationary cycles, long tails are to the upside so mean tends to be above median. But this is just one month and I’m not going to read too much into it yet.

On Fed policy: given what has happened in March, the February numbers aren’t going to be very meaningful. But the market seems to be misunderstanding the importance of the energy spike, treating it as an inflationary impulse that makes the Fed’s job difficult given weak employment data. That’s wrong. A rise in CPI that is caused by energy is not the sort of inflation the Fed leans against. That’s because energy is mean-reverting, but also very anti-growth. Remember that earlier I noted that the CPI curve was inverted but also the longer tenors were lower than a month ago? That’s probably because the inflation market is pricing a recession (which isn’t disinflationary, but the market believes it is). Anyway, if the Fed tightened into an energy price spike, they’d be making a recession worse. That was a big part of the 1970s Fed errors. The Fed knows about those errors, and so an energy price spike is more likely to produce a Fed ease in context with weak employment data, than a tightening. This isn’t stagflation, if core continues to decline. It’s stag, but headline CPI heading higher is not inflation if core/median remains tame.

(To be sure: I don’t think core and median are going to remain contained and in fact I think they are already starting the process of rolling back to the mid-to-high 3s. The Enduring Investments Inflation Diffusion Index is confidently moving higher.)

(But the Fed doesn’t believe that. We could well end up talking about stagflation properly but people will still get confused with the headline spike. Sigh.)

Here’s another important implication: given what has happened in March, the February numbers aren’t going to mean much for policy, so people will move on quickly from this especially as they were close to expectations. But, the NSA increase this month was +0.47%, so that is what matters for USDi. In March, USDi will increase 0.37% (4.5% annualized). In April, it will increase +0.47% (5.8% annualized). And here’s the thing: right now the inflation swaps market is pricing March CPI at +0.91% NSA…if that happens, then the May USDi increase will be at an 11% annualized rate…

The bottom line for this report is that February’s number is going to be swiftly forgotten. The next few are going to be very exciting, and not in a good way!