Why is the Federal Reserve still holding steady despite the decline in the U.S. February CPI and PPI?

According to Zhitong Finance APP, although the U.S. February inflation data released this week brought some encouraging news on the surface, there are actually signs that the Federal Reserve may remain inactive on interest rates.

Data released by the U.S. Department of Labor on Wednesday showed that the U.S. February CPI rose 2.8% year-on-year, the lowest since November last year; the U.S. February CPI rose 0.2% month-on-month, the lowest since October last year. The U.S. February core CPI (excluding food and energy) rose 3.1% year-on-year, the lowest since April 2021; the U.S. February core CPI rose 0.2% month-on-month, the lowest since December last year.

Data released on Thursday showed that the U.S. February PPI was flat month-on-month, the smallest increase since July last year; the core PPI fell 0.1% month-on-month, far below economists' general expectation of a month-on-month increase of 0.3%, and significantly cooled compared to the previous month's increase of 0.5%.

Both the U.S. February CPI and PPI data were below expectations, but this does not necessarily reflect in the inflation indicators favored by the Federal Reserve. Several economists stated that due to some complex mathematics behind the overall data and trends in several key areas, policymakers are unlikely to feel reassured by these data.

Bank of America economist Stephen Juneau stated, "In short, the inflation process in 2025 is off to a bad start. Our forecast for PCE further confirms our view that inflation is unlikely to fall to a level that would allow the Federal Reserve to cut interest rates this year, especially in the context of policy changes pushing inflation higher. Unless economic activity data weakens significantly, we still expect the Federal Reserve will not adjust policy rates throughout the year."

The market currently largely agrees with this view. According to the CME "FedWatch," traders almost believe that the Federal Open Market Committee (FOMC) meeting next week is unlikely to cut rates, with the possibility of a rate cut in May being only about one-quarter.

While the Federal Reserve will pay attention to the CPI and PPI data released by the U.S. Bureau of Labor Statistics, it believes that the ultimate measure of inflation is the PCE price index from the U.S. Department of Commerce. Federal Reserve officials believe that PCE data—especially the core PCE that excludes food and energy prices—can more comprehensively reflect price trends. This index more accurately reflects consumers' actual consumption situations than CPI or PPI, which only reflect price changes of individual goods and services. For example, if consumers substitute chicken for beef, the PCE index would more clearly reflect this trend, while CPI and PPI may not.

Most economists expect that the latest PCE price index, to be released later this month, will maintain a year-on-year increase of at most 2.6%, or may even rise slightly—indicating that inflation will further deviate from the Federal Reserve's 2% target.

Krishna Guha, global policy and central bank strategy head at Evercore ISI, stated, "The PPI data released on Thursday confirmed our concerns that the seemingly mild inflation data in February may translate into higher readings for PCE inflation." "PCE inflation is unlikely to decline steadily in early Q2; instead, it may exhibit volatility." According to the analysis by Sam Tombs, Chief U.S. Economist at Pantheon Macroeconomics, price increases in certain areas of the PPI data may transmit to the PCE inflation indicator, including: rising hospital care costs, increasing insurance prices, and higher air transportation costs. He stated, "This outcome will almost certainly cause the Federal Reserve to retreat."

Sam Tombs expects that the core PCE price index in the U.S. will rise by 2.8% year-on-year in February, up from 2.6% in January. Bank of America and Citigroup predict this indicator to be 2.7%, which is generally consistent with forecasts from other Wall Street institutions. Nevertheless, these predictions indicate that inflation in the U.S. is moving in the wrong direction.

It is worth noting that some positive changes may still occur in the future. Although the market generally expects inflation to rebound in February, many economists still believe that inflation will decline in the coming months, even considering the impact of tariffs. Citigroup expects that the inflation data in March will be "more favorable" and predicts that the Federal Reserve may resume rate cuts in May—this view differs from the mainstream market predictions, which currently suggest a higher likelihood of rate cuts in June.

U.S. Stagflation Clouds Loom as the Federal Reserve Faces a Dilemma

Despite the inflation data released this week being lower than expected, it remains significantly above the 2% target. Worse still, the non-farm report for February, released in early March, shows that the U.S. job market has already cooled, and may further be impacted by layoffs from the U.S. government, raising concerns about stagflation in the U.S. economy.

The Federal Reserve strives to achieve its "dual mandate" of maintaining price stability and maximizing employment. However, these two goals are currently in conflict, putting the Federal Reserve in a dilemma—if it lowers interest rates to support the labor market, there is a risk of reigniting inflation; if it maintains high interest rates for an extended period to curb price increases, the economy may fall into recession.

At the same time, the inflation effects and economic shocks caused by the tariff policies of the Trump administration will pose greater challenges. Since taking office, Trump has frequently wielded the tariff stick, imposing tariffs on trade partners such as Canada, Mexico, and China, and has repeatedly threatened to impose tariffs on the European Union.

These tariff measures from the Trump administration have already led to a surge in consumer inflation expectations. Analysts point out that in the short term, the tariffs imposed by the U.S. have led to rising prices for imported goods, primarily manifesting as a one-time pulse increase in inflation. However, in the long term, if tariffs trigger a restructuring of global supply chains or provoke retaliatory measures from other countries, it could lead to decreased production efficiency and a systematic rise in trade costs, creating persistent inflationary pressures.

The tariff policies of the Trump administration have undermined the confidence of investors, consumers, and businesses, raising concerns about an economic recession. Bruce Kasman, Chief Economist at JP Morgan, stated that the probability of a recession in the U.S. this year is about 40%, up from his earlier estimate of around 30%. He also mentioned that if the U.S. government undermines people's trust in American governance, the status of the U.S. as an investment destination could suffer lasting damage Bruce Kasman stated that if the reciprocal tariffs threatened by Trump come into effect in April, the risk of economic recession will rise, potentially reaching 50% or more. "If we continue down this more destructive and business-unfriendly policy path, I believe the risk of recession will increase."

Some market participants believe that the Federal Reserve may continue to adopt a "data-dependent" strategy, and there will not be a significant one-sided tilt in policy. If inflation expectations rise, there will be moderate reinforcement of maintaining high interest rates until inflation falls; conversely, if inflation is controlled while unemployment rises, signals for further easing of policy will be released.

If the U.S. economy falls into a "stagflation" predicament, the Federal Reserve's monetary policy focus may shift towards inflation. Analysts point out that historical experience shows that when inflation expectations are severely out of control, the Federal Reserve often prioritizes stabilizing prices, even at the cost of economic growth and employment. For example, in the 1980s, then-Federal Reserve Chairman Paul Volcker suppressed inflation through aggressive interest rate hikes, which exacerbated economic recession and unemployment in the short term, but ultimately achieved price stability and laid the foundation for long-term growth