Drew Peterson, CFA, CIPM®, Macro Strategist and Director of Corporate Credit Research
At Face Value, A Favorable Reading
Headline inflation came in a tenth better than expected at +0.2% with core in line at +0.3%. Annualized inflation rates in turn fell to +2.4% and +2.5%, respectively. The market seized on this report as further progress in the “last mile” fight against inflation; longer rates fell modestly, and the futures market began pricing in about a 50-50 possibility of a third Fed Funds Rate cut before year-end. However, we’re less convinced and believe the market may be overlooking a few issues with the report, and that longer-term trends remain in place that could make further improvement difficult.
Problems With January’s Report
A smaller of two concerns is that the annual inflation rates are still being understated due to the government shutdown. As a matter of policy, the Bureau of Labor Statistics rolls forward prior prices from its inflation surveys when new ones are not available. With the department closed for all of October and the first third of November, October inflation was limited to what could be retroactively sampled after the government reopened. BLS didn’t publish full constituent-level data for the impacted period, but they’ve disclosed at a minimum that commodities, services, and shelter cost data were rolled forward. These categories represent about 80% of the inflation index. While monthly readings were not provided for October or November, it’s possible to derive two-month rates from the existing monthly and annual data. These rates, +0.299% for headline CPI and +0.223% for core, are in line to slightly below the typical rates both before and after the shutdown-impacted period, providing further confirmation that October’s inflation was largely not captured and November’s may have been understated as well.
Without knowing what data is missing, it’s impossible to identify exactly the impact on annual inflation, but we believe a reasonable estimate is that annual inflation would be 0.2-0.3% higher had all data been captured. Beyond that, we would note that the omissions of Shelter and Owner’s Equivalent Rent are particularly problematic because they are measured using a six-month rolling sample, so this will be somewhat understated until April, when the October period is replaced. The effect here is much harder to quantify, however. All the same, this report would still represent improvement, had it not been for a larger problem we see.
Annual Data Can Mask Important Details
Annual inflation rates can be problematic despite longer periods smoothing volatility, as they may obscure changes in the trend and composition of data over that period. And progress has been uneven over the last year. Monthly data shows inflation bottomed out in the spring and early summer, with unusually light readings in February through May during a period of economic turmoil related to the “Liberation Day” tariff proposals. Inflation then picked back up in the second half, and while there was a brief surge in Core Goods inflation, virtually all recent inflation is attributable to Core Services.
This component was elevated the entire second half of the year and hit its highest level since January 2025 in the most recent report, at +0.388%. The Fed’s “supercore” gauge surged as well, to +0.593%, also reaching 12-month highs. There are likely seasonal effects at play here, but with almost every category except Shelter heating up in January and most running hotter than at any point in the second half of 2025, this broad-based increase should give the market pause. For now, it isn’t.
Why We’re Cautious on Inflation
First, services inflation tends to be somewhat stickier than goods inflation, so pricing pressures are more likely to persist in the near term. Second, it means base effects will be working against improvement in annual inflation for the next several months. As each new inflation reading is captured, the year-ago value drops out of the trailing 12-month window, and the annual rate falls if the new value is lower than the old one. January’s core CPI is a great example of this, as the monthly rate of +0.3% is still somewhat elevated, but it was an improvement over the January 2025 reading of +0.4%; accordingly, the annual rate dropped by a tenth.
The problem for future readings is that year ago comparisons are going to get harder; between February and May of 2025, monthly inflation averaged +0.15% at the headline level and +0.18% at the core level. Excluding the shutdown impacted two-month period, the average over the last six months has been significantly higher, +0.28% headline and +0.26% core. Further improvement will require monthly inflation to fall close to 50% from where it was in the second half of the year. That’s possible, and 2025 wasn’t the only year with a period of spring and early summer inflation weakness, but the recent shift to the bulk of price pressures coming from services is not encouraging.
Absent improvement from the current trend, base effects will also begin pushing annual inflation back up. Assuming the recent monthly averages continue for the next several months, headline inflation would be approaching +3.1% and core +2.9% by July, when the market currently expects the Federal Reserve to begin cutting rates. If this were to be the case, we do not see them voting to cut.
Our read on the Fed’s dual mandate for several months now has been that the labor markets are soft, but maybe a little stronger than the consensus holds, while inflation is trending in the right direction, but also a little hotter than consensus. January’s Nonfarm Payrolls, and particularly the trend in the Household survey, reinforced our labor market view, while January’s CPI has the consensus moving further away from where we see fundamentals. If data continues to support this view, market expectations for rate cuts in the second half of the year will have to change.
This commentary reflects the opinions of Appleton Partners based on information that we believe to be reliable. It is intended for informational purposes only, and not to suggest any specific performance or results, nor should it be considered investment, financial, tax or other professional advice. It is not an offer or solicitation. Views regarding the economy, securities markets or other specialized areas, like all predictors of future events, cannot be guaranteed to be accurate and may result in economic loss to the investor. While the Adviser believes the outside data sources cited to be credible, it has not independently verified the correctness of any of their inputs or calculations and, therefore, does not warranty the accuracy of any third-party sources or information. Specific securities identified and described may or may not be held in portfolios managed by the Adviser and do not represent all of the securities purchased, sold, or recommended for advisory clients. The reader should not assume that investments in the securities identified and discussed are, were or will be profitable. Any securities identified were selected for illustrative purposes only, as a vehicle for demonstrating investment analysis and decision making. Investment process, strategies, philosophies, allocations, performance composition, target characteristics and other parameters are current as of the date indicated and are subject to change without prior notice. Registration with the SEC should not be construed as an endorsement or an indicator of investment skill acumen or experience.
"Uncertainty is the norm in the capital markets, yet municipal bond investors have recently been forced to grapple with unusually high levels. Record YTD net issuance, monetary policy questions, and a recent government shutdown have all led to unsettled markets..."
"New York City recently published the Comptroller’s monthly “By the Numbers” report that confirmed that YoY tax revenue collections for FY25 increased by $6.1B (+8.3%) to $80.3B. Property taxes (43% of total revenue) rose 5.4% YoY, while non-property taxes surged by a combined 10.6%..."
Economic & Market Commentary
02.23.2026
January Offers Headline Inflation Relief, Although Concerns Remain
Drew Peterson, CFA, CIPM®, Macro Strategist and Director of Corporate Credit Research
At Face Value, A Favorable Reading
Headline inflation came in a tenth better than expected at +0.2% with core in line at +0.3%. Annualized inflation rates in turn fell to +2.4% and +2.5%, respectively. The market seized on this report as further progress in the “last mile” fight against inflation; longer rates fell modestly, and the futures market began pricing in about a 50-50 possibility of a third Fed Funds Rate cut before year-end. However, we’re less convinced and believe the market may be overlooking a few issues with the report, and that longer-term trends remain in place that could make further improvement difficult.
Problems With January’s Report
A smaller of two concerns is that the annual inflation rates are still being understated due to the government shutdown. As a matter of policy, the Bureau of Labor Statistics rolls forward prior prices from its inflation surveys when new ones are not available. With the department closed for all of October and the first third of November, October inflation was limited to what could be retroactively sampled after the government reopened. BLS didn’t publish full constituent-level data for the impacted period, but they’ve disclosed at a minimum that commodities, services, and shelter cost data were rolled forward. These categories represent about 80% of the inflation index. While monthly readings were not provided for October or November, it’s possible to derive two-month rates from the existing monthly and annual data. These rates, +0.299% for headline CPI and +0.223% for core, are in line to slightly below the typical rates both before and after the shutdown-impacted period, providing further confirmation that October’s inflation was largely not captured and November’s may have been understated as well.
Without knowing what data is missing, it’s impossible to identify exactly the impact on annual inflation, but we believe a reasonable estimate is that annual inflation would be 0.2-0.3% higher had all data been captured. Beyond that, we would note that the omissions of Shelter and Owner’s Equivalent Rent are particularly problematic because they are measured using a six-month rolling sample, so this will be somewhat understated until April, when the October period is replaced. The effect here is much harder to quantify, however. All the same, this report would still represent improvement, had it not been for a larger problem we see.
Annual Data Can Mask Important Details
Annual inflation rates can be problematic despite longer periods smoothing volatility, as they may obscure changes in the trend and composition of data over that period. And progress has been uneven over the last year. Monthly data shows inflation bottomed out in the spring and early summer, with unusually light readings in February through May during a period of economic turmoil related to the “Liberation Day” tariff proposals. Inflation then picked back up in the second half, and while there was a brief surge in Core Goods inflation, virtually all recent inflation is attributable to Core Services.
This component was elevated the entire second half of the year and hit its highest level since January 2025 in the most recent report, at +0.388%. The Fed’s “supercore” gauge surged as well, to +0.593%, also reaching 12-month highs. There are likely seasonal effects at play here, but with almost every category except Shelter heating up in January and most running hotter than at any point in the second half of 2025, this broad-based increase should give the market pause. For now, it isn’t.
Why We’re Cautious on Inflation
First, services inflation tends to be somewhat stickier than goods inflation, so pricing pressures are more likely to persist in the near term. Second, it means base effects will be working against improvement in annual inflation for the next several months. As each new inflation reading is captured, the year-ago value drops out of the trailing 12-month window, and the annual rate falls if the new value is lower than the old one. January’s core CPI is a great example of this, as the monthly rate of +0.3% is still somewhat elevated, but it was an improvement over the January 2025 reading of +0.4%; accordingly, the annual rate dropped by a tenth.
The problem for future readings is that year ago comparisons are going to get harder; between February and May of 2025, monthly inflation averaged +0.15% at the headline level and +0.18% at the core level. Excluding the shutdown impacted two-month period, the average over the last six months has been significantly higher, +0.28% headline and +0.26% core. Further improvement will require monthly inflation to fall close to 50% from where it was in the second half of the year. That’s possible, and 2025 wasn’t the only year with a period of spring and early summer inflation weakness, but the recent shift to the bulk of price pressures coming from services is not encouraging.
Absent improvement from the current trend, base effects will also begin pushing annual inflation back up. Assuming the recent monthly averages continue for the next several months, headline inflation would be approaching +3.1% and core +2.9% by July, when the market currently expects the Federal Reserve to begin cutting rates. If this were to be the case, we do not see them voting to cut.
Our read on the Fed’s dual mandate for several months now has been that the labor markets are soft, but maybe a little stronger than the consensus holds, while inflation is trending in the right direction, but also a little hotter than consensus. January’s Nonfarm Payrolls, and particularly the trend in the Household survey, reinforced our labor market view, while January’s CPI has the consensus moving further away from where we see fundamentals. If data continues to support this view, market expectations for rate cuts in the second half of the year will have to change.
This commentary reflects the opinions of Appleton Partners based on information that we believe to be reliable. It is intended for informational purposes only, and not to suggest any specific performance or results, nor should it be considered investment, financial, tax or other professional advice. It is not an offer or solicitation. Views regarding the economy, securities markets or other specialized areas, like all predictors of future events, cannot be guaranteed to be accurate and may result in economic loss to the investor. While the Adviser believes the outside data sources cited to be credible, it has not independently verified the correctness of any of their inputs or calculations and, therefore, does not warranty the accuracy of any third-party sources or information. Specific securities identified and described may or may not be held in portfolios managed by the Adviser and do not represent all of the securities purchased, sold, or recommended for advisory clients. The reader should not assume that investments in the securities identified and discussed are, were or will be profitable. Any securities identified were selected for illustrative purposes only, as a vehicle for demonstrating investment analysis and decision making. Investment process, strategies, philosophies, allocations, performance composition, target characteristics and other parameters are current as of the date indicated and are subject to change without prior notice. Registration with the SEC should not be construed as an endorsement or an indicator of investment skill acumen or experience.
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