The release of the latest inflation data underscores the persistent nature of price pressures within the economy. This strengthens the Federal Reserve’s resolve to maintain elevated interest rates for a longer duration. The ‘core’ Personal Consumption Expenditures index, a key metric favored by the Fed, registered a 2.8% year-over-year increase for March. While level with February’s readings, it exceeded market expectations marginally. On a month-over-month basis, the inflation gauge rose 0.3%, aligning with forecasts.
These persistently high readings have implications for the timing of potential interest rate cuts. Market sentiment has shifted away from the anticipation of cuts earlier in the year. One of our analysts suggests that a robust series of favorable inflation reports will be necessary for the Fed to feel confident in easing monetary policy. Currently, investors are becoming more aligned with the possibility of a rate cut in September, but the odds remain below 50%.
Prior to this recent data, some market participants were considering a potential rate cut as early as July. Our analysts now see that possibility as unlikely unless we witness a simultaneous acceleration in inflation decline and a notable weakening of economic indicators.
In recent commentary, the Fed Chair hinted that the March PCE reading might not demonstrate the anticipated progress. Moreover, he highlighted that recent inflation measures, calculated on three- and six-month intervals, now reflect higher levels.
This shift in the Fed Chair’s outlook is significant. It marks a departure from his previous message of relative consistency in economic conditions, despite the somewhat unexpected data releases earlier this year. The Chair now emphasizes a more protracted period before policymakers gain the confidence to bring inflation definitively down to the 2% target.
While some analysts believe that rate cuts could still commence in July of this year, they anticipate continued downward pressure on inflation as the year unfolds. Their forecasts suggest three cuts this year remain possible. They attribute the early 2024 inflation increase to seasonality and housing costs.
One analyst points out that even with the 2.8% inflation reading, the economy is operating within range of the central bank’s 2.6% annual forecast for the year’s end. Further, some historical precedent indicates that the Fed has, at times, initiated rate easing before reaching the 2% inflation target.
Looking at the six-month annualized core PCE inflation figure, it currently stands at 3%. The three-month measure, on the other hand, has experienced a significant jump to 4.4%. One of our risk analysts believes the large January inflation reading, potentially driven by seasonal factors, is skewing the figures upward. Nonetheless, these statistics offer a point of concern for the Fed and raise the specter of possible renewed inflation acceleration.
Overall, the current inflation environment can hardly be described as favorable for the Federal Reserve. One analyst characterizes it as likely to complicate their decision-making regarding the timing of rate cuts. However, if stubbornly high inflation continues, the conversation could quickly switch from rate cuts to a potential return to interest rate hikes.
