The March consumer price index perfectly captured the initial energy shock caused by the war in Iran that is working through the U.S. economy, as inflation increased by 0.9% on the month and by 3.3% compared to a year ago.
On a three-month annualized pace, the CPI increased by 5.3% and on a six-month basis it was up by 3.7%, according to data released by the Bureau of Labor Statistics on Friday.
In our estimation the initial shock caused by the war will be a movement in two parts, with the first observed in March and the second in April in which we see a chance that real wages turn negative. Real wages, which account for inflation, slowed to a 0.3% increase in March, down from 1.4% in February.
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The solution to inflation is time and supply. The Federal Reserve will remain on hold until it gets a better sense of the magnitude and persistence of the shock.
The policy pathway from here is patience on the part of the Fed and pain on the part of the American public.
The primary driver of the increase was a 10.9% shock to the energy index on the month, a 21.3% increase in energy commodities and 21.2% rise in gasoline prices while fuel oil prices increased by 30.7%. From one year ago, energy prices increased by 12.5%, fuel oil by 44.2%, motor fuel by 19.2%, gasoline by 18.9% and energy services by 5%.
Policy implications
Despite the oil and energy shock, the Federal Reserve can, will and should look through the early days of a supply shock, which supports the need for patience.
Neither rate cuts nor rate hikes make sense at this time given the rapidly changing risk matrix that the central bank is facing.
We expect that the central bank will be on hold until the Fed can estimate if the energy shock starts to bleed into the core inflation rate and dislodges inflation expectations. That holding period should be another two or three months.
In addition, we are in our sixth year of inflation staying well above the Fed’s 2% target, which denotes some risk that the public and professional investors will revise their expectations of higher inflation, which does not help the Fed’s cause.
We would expect that the Fed will be more attentive to inflationary risk as it tries to strike a balance in its dual mandate of price stability and employment.
That means no rate cuts in the first half of the year. If we get any relief through the rate channel it will be late 2026 unless the labor market deteriorates in the near term.
The data
Core inflation increased by 0.2% and was up by 2.6% from a year ago. Given the sharp increase in energy costs, one should anticipate a second round of effects within transportation, travel and food prices as firms pass through rising prices.
Service sector prices increased by 0.2% on the month and by 3.1% annually. Excluding energy, those prices increased by 0.2% on the month and by 3% over the past year.
Just as important, the policy-sensitive owners’ equivalent rent series increased by 0.3% monthly and by 3.1% annually while housing and shelter costs increased by 0.3% monthly and by 3.4% and 3% compared to a year ago, respectively.
One of the sources of optimism on disinflation at the turn of the year was an expectation that housing, shelter and owners’ equivalent rent would provide relief to top-line costs. But with the March data now in the books, it is not clear that relief will be seen.
Transportation costs jumped by 4.3% on the month and by 5% annually as one might have anticipated. New vehicle prices increased by 0.1% on the month and used car and truck costs declined by 0.4%.
Airline fares increased by 2.7% and rose by 14.9%. They should be expected to jump sharply because of the shock to jet fuel prices.
Food and beverage costs were flat on the month and rose by 2.6% from a year ago.
Apparel costs increased by 1% in March, recreation costs were flat, education prices increased by 0.2% and commodity prices jumped by 2%.
The takeaway
The policy pathway to address the initial phase of the oil and energy shock will be patience on the part of the Federal Reserve and pain on the part of the American public.
The energy shock will evolve like a symphony in two movements. The first was in March, which showed up inside the energy complex, and the second will follow in April and beyond in the broader transportation, travel, food and service categories.
The size of the energy shock is such that businesses and households should not anticipate any near-term relief. The price shock will be with all of us for the rest of the year.
