High CPI Underimines Some Recent Attempts to Dismiss High Core PCE Deflator -- Argues for Fed Rate Hike

 The high 0.3% m/m February Core CPI looks to have reflected widespread increases and points to a 0.2-0.3% Core PCE Deflator.  Along with the stronger-than-consensus jump in February Housing Starts, today's CPI report adds to the wide span of US economic data arguing for a Fed rate hike this afternoon.

     a.  The largest increase in the CPI was the +1.6% m/m Apparel.   Bi-monthly sampling and possibly early introduction of higher-priced Spring clothing (due to the relatively warm winter) were likely partly responsible.  But, the increases were sizable in other components, as well.

    b.  The underlying components of Housing Starts/Permits were strong, as well -- both 1-Family Starts and Permits rose m/m.

The high CPI print undermines two recent attempts to dismiss the significance of the high 1.7% y/y print in the January Core PCE Deflator (see below).  Both argue that base effects boosted the y/y in January and that the y/y pace is likely to fall back in coming months.

Here's where they could be wrong:

    a.   A 0.2-0.3% m/m February Core PCE Deflator should translate into 1.7-1.8%, with 1.8% the better chance (and assuming no revision to January).   The February 2015 Core PCE Deflator rose 0.13% m/m, so the base effect helps to boost the y/y in February.

    b.  The m/m percent change in the Core PCE Deflator averaged a modest 0.13% m/m from February through December 2015, and it is more likely that it will average at least that pace for the rest of 2016.

The two benign views of the January Core PCE Deflator are:

1.  Morgan Stanley economists argue that the high January Core PCE Deflator resulted from favorable base effects, according to a Bloomberg news story.  MS economists think that the 1.7% y/y will be the peak for the year.

2.  Fed Governor Brainard also attributed  the high print to base effects.  She said in a footnote in her latest speech: "Because the most recent 12-month change in core PCE prices includes several relatively large monthly increases in core PCE prices in the first part of 2015, it is possible that 12-month core PCE inflation will move lower in coming months as these relatively large monthly increases drop out of the 12-month window."

      a.  This is actually backwards with regard to how base effects impact the y/y calculation.  The y/y is lifted when the current month is compared to a relatively soft print 12 months earlier.