The core services ex-energy & shelter CPI climbed 0.70% m/m in January, the largest m/m gain since September 2022. On a 3- & 6-month annualised basis, this measure of core services prices jumped 6.29% and 5.60%, respectively. The case for the Fed to hold steady on rates through 2024 remains compelling, even more so following Tuesday’s CPI report. There was far too low a probability attached to this scenario heading into this year, following the sharp rally in Treasuries in November and December.
There may still be one or two adjustment cuts this year. This is more likely than another Fed hike. But this debate shouldn’t obfuscate the broader picture, which is that this economy requires much higher real yields vis-à-vis the pre-pandemic period.
Medical care services inflation – which has a larger weight in the PCE price index (16.1%) compared to the CPI (6.5%) – has turned up of late, contributing to the pickup in core services inflation. This is not insignificant. Hospitals and other healthcare providers continue to face higher costs, and this should translate into higher health insurance premiums moving forward, because these contracts are often negotiated every few years.
Fiscal pressures from demographics will not abate. Federal outlays on major healthcare programmes are projected to rise from 5.8% of GDP in FY23 to 6.7% in FY34. Perpetually loose fiscal policy will alter equilibrium real interest rates. The Fed will have to begin engaging seriously with important questions around how demographics, climate change, and fiscal policy will impact on neutral real rates moving forward.
