The much-awaited inflation data for the month of February was released yesterday. The headline Consumer Price Index (CPI) rose by 0.3% on the month, settling at 1.7% in February. While the rise was expected, and it confirms the recent increase in inflation expectations, the surprise came from the Core CPI.
The core inflation excludes volatile prices, such as energy prices and transportation. It declined in February by -0.1%, settling at 1.3% for the month. To traders, the data poses a puzzle because the core inflation is the Fed’s favored measure of inflation. If the core stalls, how long will it be until the Fed sees inflation high enough to warrant a rate hike under its new Average Inflation Targeting (AIT) mandate?
Details of February 2021 U.S. CPI Report
Because inflation is part of every central bank’s mandate, it is a key driver of market volatility. It plays a critical role in the currency market’s volatility, as higher or lower interest rates trigger sharp moves in a currency pair’s exchange rate.
The drop in core inflation took the market by surprise. While we did not see a sharp move in the U.S. dollar, the expectations were that the core data would rise as well. It did not – just the opposite.
When compared to the preceding months, core inflation was driven down mainly by core goods. Prices of core goods were down sharply in February, falling by the most in twelve months or so. Core services, on the other hand, rose by 0.2%. These are small details in the data, but the main point is that inflation is not rising as fast as many have feared, fueling optimism about the impact of the new fiscal stimulus package.
America’s response in the fiscal space to the health crisis exceeded anything seen in other parts of the world. Naturally, worries arise that by issuing too many dollars, America intends to debase its currency so as to become more competitive. Also, America is a net borrower, so one may easily choose to pay its debt by printing more of its own currency.
The first sign in such a scenario should come from the monthly inflation data. So far, there is nothing to worry about, but every month from not on, traders and investors will keep an eye on the core inflation rising above the 2% level. From that moment on, the averaging begins, if only the Fed will let the market know the period it considered for its new AIT mandate.