February CPI report: a critical pre-Fed meeting indicator set to shape market futures

The highly anticipated February US Consumer Price Index (CPI) report, set for release on Tuesday, has gained extra significance as the last major economic indicator before the Federal Reserve's March meeting. With inflation remaining high, this monthly overview of price pressures across the economy will be key in shaping market expectations and potentially guiding the central bank's policy direction.

US inflation – market expectations

Consensus forecasts suggest the headline CPI will hold steady at 3.1% year-over-year (YoY) for February, while the core measure, excluding volatile food and energy components, is projected to slightly decrease to 3.7% YoY from January's 3.9%. Monthly, the headline CPI is expected to increase to 0.4%, up from 0.3%, with the core figure anticipated to drop to 0.3%, down from January's 0.4%.

Although these projections indicate inflation rates higher than what policymakers desire, they could signify that underlying inflationary pressures are not worsening. However, a significant deviation from consensus, especially upwards, could unsettle markets and lead to a re-evaluation of the Fed's policy outlook.

Market reaction and policy implications

Financial markets typically respond sensitively to CPI data, with the S&P 500 often falling on higher-than-expected figures, and the US dollar usually strengthening. The average movement in the S&P 500 on CPI announcement days has been +/-0.8% over the past six months, the highest since April.

While a single inflation report is unlikely to dramatically change the Fed's overall stance, a trend of unexpectedly high data could lead to a revision of the anticipated number and timing of rate cuts this year. A higher February CPI could significantly increase the likelihood of the median 2024 dot in the FOMC's March Summary of Economic Projections (SEP) indicating 50 basis points of easing this year, rather than the current median projection of 75 basis points.

CPI and the Fed’s preferred gauge

It's important to note that the CPI and the Fed's preferred Personal Consumption Expenditures (PCE) price index often differ. The "Owners' Equivalent Rent" (OER) has a much larger weight in the core CPI than in the core PCE, which can lead to discrepancies in policy outlook conclusions if relying solely on the CPI.

Long-term inflation trajectory

Market participants will also closely watch the 3- and 6-month annualised rates of core CPI for insights into the direction of underlying inflation trends. These metrics are increasingly significant as the Federal Open Market Committee (FOMC) seeks "confidence" in returning to its 2% inflation target before initiating the first rate cut. The core services category, especially OER, is expected to continue driving inflation upwards, with January's report showing a surge due to a re-weighting by the Bureau of Labor Statistics (BLS), potentially affecting future core CPI figures.

A vital data point for investors

As the last crucial data piece before the March FOMC meeting, the February CPI report stands as a pivotal event for shaping market expectations and influencing central bank policy discussions. While forecasts hint at a slight easing of inflationary pressures, any unexpected figures could lead to a reevaluation of the Fed's rate outlook and cause significant movements across various asset classes.