Sticky Inflation, Weak Labor Market

The stock market should continue to be impacted by developments in the Iranian war this week, particularly as they affect oil prices.  In addition, it will contend with inflation news in the February CPI and January PCE Deflator releases, some of which may be disappointing.  The Fed will probably keep policy steady at the following week's FOMC Meeting, balancing upside risks to inflation with downside risks to the labor market.  

Consensus looks for good news from the February CPI, expecting Total and Core to climb by only 0.2% m/m.  The y/y would be steady at 2.5% for Core and edge up to 2.5% from 2.4% for Total.  Both are not far above the Fed's 2% inflation target.  A consensus print looks reasonable, but it could require Owners' Equivalent Rent (OER) to stay modest at 0.2%, Used Car Prices to be benign, and Airfares to flatten after jumping in January.  

In contrast, consensus expects a high January PCE Deflator, with Total up 0.3% m/m and Core up 0.4%.  The y/y would be steady at 2.9% for Total and rise to 3.1% from 3.0% for Core.  A higher print than January's CPI (0.2% Total and 0.3% Core) is a reasonable expectation, given that the drop in Used Car Prices, which helped hold down the CPI in January, has minimal impact in the PCE Deflator.  And, OER has a smaller impact in the PCE Deflator than in the CPI.  Also, Airfares were high in both the PPI and CPI in January, so will be the same in the PCE Deflator. 

The weak February Employment Report balances any bad news coming from the inflation reports.  The -92k m/m drop in Nonfarm Payrolls resulted from widespread declines among sectors.  Eight of the eleven major sectors posted declines.   Bad weather may have been a factor behind the decline, but so may have AI, hiring caution, or weaker labor demand.  The Fed will most likely want to see whether the labor market weakness was temporary or the start of a more prolonged issue that requires a policy response.  So, it is not likely to respond immediately with a policy easing.

Despite the uptick in the Unemployment Rate to 4.4% from 4.3%, wage inflation remained high for the second month in a row.  Average Hourly Earnings (AHE)  rose 0.4% m/m in both January and February.  The January increase could have been just an offset to the low 0.1% in December.  However, the large February increase is troubling for the Fed's 2% inflation target.  Large wage increases were widespread, with 8 of 13 sectors posting increases of 0.4% or higher.  The Report followed the release of Q425 Compensation/Hour (the broadest measure of labor costs), which also was high.  This measure jumped 5.7% (q/q, saar).   Although the jump could have just reflected volatility, its y/y did not show any softening.  It rose 4.1%, the same as the increase over 2025.   At best, it signals that inflation is likely to remain sticky.

To be sure, the high February AHE could reflect a compositional shift toward higher-paid workers, perhaps because fewer lower-paid new workers are being hired.  It (as well as January's) could have reflected hikes in the minimum wage in some states, as well.  In any case, the Fed will probably want to wait and see if last year's downtrend in wage inflation has ended or will resume.