Hot inflation data dims prospects for a Fed rate cut in June

REAL ECONOMY BLOG | April 10, 2024

Authored by RSM US LLP

The U.S. consumer price index came in above expectations for March, putting the Federal Reserve in a difficult position as it seeks to starting cutting interest rates this year.

Both overall and core inflation remained unchanged at 0.4% monthly, the third consecutive month that the overall CPI index has defied what had been a downward trajectory, according to government data released Wednesday.

Inflation’s recent persistence certainly challenges the Fed’s narrative of transient inflation pressures. The year-ago metrics rose to 3.5% from 3.2% for overall inflation and stalled at 3.8% for the core inflation reading.

With only two more CPI reports before the Federal Reserve’s June meeting, the likelihood of a rate cut is diminishing. This sentiment is reinforced by the super-core inflation figure, which, excluding shelter costs, surged by 0.7% on the month.

Financial markets are now pricing in the probability of a Fed cut in June at around 20%, a sharp drop from the greater than 50% chance that was priced in before the data release.

The bulk of inflationary gains continued to show up in the shelter and car insurance sectors, areas expected to regress eventually. Shelter inflation rose by 0.4% on the month, unchanged from February, while car insurance rose by 2.6%, up from 0.9%.

In addition, core goods inflation resumed its decline after a brief rebound in February, falling by 0.2%. Energy inflation moderated following its February spike, rising by 1.1% compared with 2.3% previously.

Despite the elevated overall number for March, we don’t think there is enough evidence to sound the alarm yet. It’s reasonable to anticipate that the downward trend in inflation may resume within the next month or two, as the factors contributing to the recent uptick appear temporary. While this report suggests a pause in the decline of inflation, it’s unlikely to signify a prolonged deviation from the overall downward trend yet.

It’s important to note that we should not rely entirely on the consumer price index but more on the personal consumption expenditures index, which is the Fed’s preferred measure, to correctly gauge where the Fed’s interest rates might be headed.

Unlike CPI, PCE data offers a better picture of inflation with less noise and it covers the shifts in spending behaviors against inflation. PCE inflation was at 2.5% last month, and even if we see another high inflation reading, the Fed’s main indicator should stay below 3%.

If our predictions about housing and car insurance inflation calming down over the summer come true, inflation could level off at around 2.5%. That would give the Fed plenty of reasons to think about lowering its benchmark rate this year.