The February consumer price index will illustrate sticky service sector inflation that remains at or near 4%.
As economic growth slows and service sector inflation remains elevated, conditions are coalescing around risks to the economic outlook of stagnation at best and stagflation at worst.
In January, service sector inflation stood at 4.3%, services ex-energy at 4.4% and core services ex-housing at 4%. Those levels are likely not to ease much in the February data, which will be released on Wednesday.
We expect top-line inflation for February to increase by 0.4% and core by 0.3%, which translates into a 3% and 3.3% rise from one year ago. Such data will not provide any relief to central bankers observing the evolution of the data amid disruption to the trade channel through tariffs that will send prices higher in the near term.
The worst of all worlds for the Federal Reserve would be a slowing of growth well below the 1.8% long-run trend as top-line inflation remains above 2.5% and service sector inflation sits at or above 4%.
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That scenario would stimulate a policy discussion for the Fed around what to do under conditions that approximate stagflation.
Despite all of the attention around re-industrialization, the U.S. economy is a service-based entity with a 4.1% unemployment rate and wage growth of 4% that will keep demand for services robust, even as a budding inventory correction in the manufacturing sector becomes a risk to the growth outlook.
Despite the trading community pricing in three rate cuts this year, employment, wage and inflation data imply a Fed that may be reluctant to reduce rates into an economy that is slowing amid sticky inflation.
Central bankers, unlike market participants, look at stagflation as a choice. And if given that choice, higher rates are the solution.
