February CPI Report Shows Inflation Keeps Falling

A key measure of U.S. prices in February shows that inflation continues to gradually cool off in the U.S.
The Labor Department reported the Consumer Price Index (CPI) rose 6% from a year ago in February, right in line with many economists’ expectations. On a monthly basis, CPI gained 0.4% in February.
This is the lowest rate of annual CPI inflation since October 2021. It’s also a slight improvement from January’s level of inflation.
The CPI reading is the latest indicator that the Federal Reserve‘s battle against inflation is slowly chipping away at record-high prices, but the struggle remains real in 2023.
February CPI Shows Inflation Is Slowly Easing
The February data comes after January’s 6.4% year-over-year CPI came in hotter than economists had expected. Prior to 2021, the CPI hadn’t gained more than 4% a year in any month since 2008.
Core CPI inflation, which excludes volatile food and energy prices, was up 5.5% in February on an annual basis and up 0.5% on a monthly basis.
Key parts of the February inflation report show that many essentials are still seeing huge annual price increases. Food prices were up 9.5% compared to a year ago and energy prices were up 5.2%. Other segments continue to see big declines. Used car prices fell 13.6% compared to February 2022, for instance.
The inflation report arrives after the Labor Department reported that the U.S. economy added 311,000 jobs in February, exceeding economist expectations of 200,000 new jobs. U.S. wages were up 4.6% year-over-year in February as well, but rising prices are preventing many Americans from getting more mileage out of their paychecks.
The data is yet another sign that the Fed’s path forward in the inflation battle will likely not get any easier. In late February, the Commerce Department reported that the core personal consumption expenditures part of the PCE price index—another key inflation report—was up 4.7% in January, up slightly from December.
Core PCE is the Fed’s preferred measure of inflation. Rising PCE is a bad sign for interest rates and the economy as a whole.
Why Does CPI Matter?
Inflation has been the Fed’s top priority over the past year. The Federal Open Market Committee (FOMC) has been aggressively raising interest rates since May 2022 in an attempt to bring inflation back down near its long-term target of 2%.
The Fed has now raised interest rates eight times in the past 12 months, increasing the federal funds target rate by a total of four and a half percentage points. The Fed is also allowing up to $60 billion in Treasury securities and $35 billion in agency mortgage-backed securities (MBS) to mature and roll off its more than $8.3 trillion balance sheet per month.
The inflation battle has taken a back seat to a potential bank crisis in mid March, following the failure of Silicon Valley Bank, Signature Bank and Silvergate Capital.
Stock markets have experienced extreme volatility on fears that elevated interest rates would trigger contagion within the U.S. financial industry. On Monday, President Joe Biden reassured Americans “the banking system is safe” and the administration “will do whatever is needed” to keep it that way.
Despite banking system concerns, the February CPI number will likely pressure the Fed to continue to raise interest rates at its upcoming meeting on March 21-22.
Will the Fed Raise Rates at the March Meeting?
According to CME Group, markets see an approximately 86% chance of another quarter percentage point rate hike at the March Fed meeting, which would bring the federal funds target rate to between 4.75% and 5.0%. Markets also strongly expect the FOMC will raise rates another quarter percentage point in May.
Nancy Davis, founder of Quadratic Capital Management, notes that Fed Chair Jerome Powell has regularly used the term “disinflation” to describe economic conditions in 2023. But she says that February’s inflation reading was anything buty disinflationary.
“We are in a situation where inflation is still high and the economy is at risk for further weakening, particularly amid the recent bank failures,” says Davis. “This combination is consistent with stagflation, which is when the economy weakens during a time of elevated inflation.”
Gina Bolvin, president of Bolvin Wealth Management Group, says the recent bank failures likely completely changed the Fed’s gameplan moving forward.
“Today’s CPI came in as expected and has given the Fed flexibility. They should pause and give guidance that they will reevaluate,” Bolvin says.
Could Inflation Cause a Recession?
The Fed is navigating a difficult balancing act of raising interest rates aggressively to bring down inflation without triggering a U.S. recession.
Rising interest rates increase borrowing costs for companies and consumers, weighing on economic activity. Up to this point, the U.S. labor market has been solid, but the S&P 500‘s 19% decline since the beginning of 2022 reflects concerns on Wall Street that the Fed’s aggressive tightening measures will eventually catch up to the economy.
The New York Fed currently estimates there is a 54.4% chance of a U.S. recession within the next 12 months.
Inflation’s Impact on Stocks
Growth stocks are particularly sensitive to rising interest rates because of the models investing professionals use to value them. These so-called discounted cash flow models show that higher rates hurt the prospects of growth stocks.
Since the beginning of 2022, the Russell 1000 Growth Index is down 26.3%, while the Russell 1000 Value Index is down just 12.9%.
Rising interest rates have also hit tech stocks particularly hard. The Technology Select Sector SPDR Fund (XLK) is down 21.4% since the beginning of 2022.
However, inflation isn’t necessarily bad news for every sector of the stock market. Soaring oil, natural gas and other commodity prices helped energy sector stocks generate record profits in 2022. The Energy Select Sector SPDR Fund (XLE) is up 45.8% since the beginning of last year amid broad-based market weakness.
Jeffrey Buchbinder, chief equity strategist for LPL Financial, says the recent bank failures may actually be good news for investors by pressuring the Fed to slow down or pause its tightening.
“LPL Research maintains a slight preference for equities over fixed income, value over growth, small caps over large caps, and U.S. and developed international over emerging markets,” Buchbinder says.
What’s Next for Inflation?
In addition to a likely interest rate hike, investors will be monitoring the Federal Reserve’s commentary on the economy at its upcoming meeting on March 21-22.
The Fed will also be releasing its updated economic projections, and investors will be focused on any potential changes in its inflation projections.
The Bureau of Economic Analysis will also release the February core PCE reading on March 31.