March 13, 2025

QuickTakes

Why Cooler Inflation

Isn't Lifting Markets

February's inflation data provided conflicting stories. Both the CPI and PPI came in cooler than expected, but neither cheered the stock and bond markets. That's because the components of both gauges that feed into the Fed's preferred PCED inflation rate were actually a bit hotter. In addition, January's PPI increase was revised up from 0.4% to 0.6%. So it's unlikely that the Fed will lower the federal funds rate (FFR) anytime soon even if economic growth slows.

It won't be until March, or perhaps even sometime during Q2, that Trump's tariffs start to boost the inflation data. But in the meantime, goods inflation did decelerate in February. The final demand goods PPI fell back below 2.0% y/y to 1.7% y/y despite egg prices’ soaring 54%, which accounted for two-thirds of the 0.3% m/m increase (chart).

The final demand services PPI fell 0.2% m/m, its biggest decline since last July, bringing it back below 4.0% y/y. However, that's mostly because margins received by wholesalers and retailers (known as trade services) fell 1.0% m/m, suggesting that bottom lines are already getting squeezed by tariff effects (chart). This suggests that actual tariff costs may not be fully passed on to consumers.

In any event, February's PCED, which comes out at the end of the month and notably after next week's FOMC meeting, is expected to come in hot. Here's one reason: While CPI airfares fell 1.2% m/m and 0.7% y/y, weighing on the overall index, PPI airfares fell just 0.8% m/m and were up 2.4% y/y (chart). The PCED gets its airline transportation inflation rate from the PPI, not the CPI.

It's possible that February's core PCED inflation rate will be above 0.3% m/m, a pace that's too hot for the FOMC to cut the FFR. Even if the core PCED averages increases of 0.25% m/m this year (which is just 0.01 percentage point above the trailing 12-month average), it will breach 3.0% y/y by November and stay there (chart). Meaningful services disinflation and limited impact from tariffs on goods inflation are the unlikely prerequisites for the Fed to cut the FFR this year.

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