CPI Shows Heat Ahead of COVID-19

The Consumer Price Index (CPI) rose by 0.1% in February, on pace with January and in line with expectations. The data do not incorporate many price changes caused by the novel coronavirus (or COVID-19) disruptions, especially the significant drop in oil prices. Price gouging triggered by the outbreak on everything from bleach wipes to hand sanitizer is not accounted for in the data and is unlikely to show up, given efforts to stem gouging since the outbreak started.

Compared to one year ago, the CPI rose by 2.3%, with the biggest drivers being gasoline prices, medical care and restaurants. The gain in gasoline prices will be short-lived, given the crude oil price war between Russia and Saudi Arabia, which is aimed at harming our shale producers. The jump in medical care costs is the most disturbing as it occurred prior to the outbreak and was the largest annual jump in 12 years. There are efforts underway, particularly within government programs and the insurance industry, to cover the costs of testing for COVID-19. The surge in restaurant and bar prices in February reflected the strength in travel and tourism prior to the outbreak, which will reverse in the months to come after the recent spike in travel cancellations.

Core CPI (excluding food and energy) rose 0.2% in February, also in line with expectations and at a 2.4% pace on an annual comparison. One of the biggest drivers of core CPI strength is shelter costs, which grew at a 3.3% annual pace. A shortage of supply for entry-level housing has driven prices up, especially in the hottest job markets in the country. The recent market panic that drove the 10-year Treasury bond rate to fall below 0.5% will continue to pull down mortgage rates, now at 3.29% for a 30-year mortgage. The recent surge in refinancing, with a 79% spike in the week ended March 6, could slow the owners’ equivalent rent component of the CPI because monthly costs are pushed down by lower mortgage rates. Additionally, consumers may pull back from house shopping during this uncertain time, which could push shelter costs lower.

Bottom Line
The data is still pre-COVID-19, with only a portion of it collected at the end of February. The disinflationary effects associated with the virus will ultimately offset any temporary spike in prices due to shortages. This is yet another reason the Federal Reserve will cut rates aggressively next week; we expect another 0.5% cut with the Fed Funds rate hitting the zero lower bound by April.

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