CPI Data Influences Fed Rate Cuts

What Core CPI Miss Means for Fed Rate Cuts

by Faruk Imamovic
CPI Data Influences Fed Rate Cuts
© Getty Images/Spencer Platt

Key Takeaways

  • For Fed policymakers, a core CPI at the consensus level (+0.3%) will still be considered a "high" print and won’t change the guidance significantly. Only a substantial "miss" might start the clock for an eventual rate cut, which could be delayed until the year-end at the earliest.
  • A stronger-than-consensus core US CPI print might not significantly move USD OIS rates or the USD, while a downside print could be more impactful in the short term, potentially skewing towards a weaker USD.

Market Hesitance and Inflation Concerns

This morning, there’s a noticeable hesitance among traders compared to yesterday's enthusiasm for stocks. Despite the rally, which seemed unusual given the news of impending higher import tariffs on Chinese goods by the US administration, the direct implications for US inflation might be minor. However, the risk of Chinese retaliation and possible tariffs from the European Union could worsen commercial relations between China and the West. China's Ministry of Commerce has vowed to take action, although specifics were not provided.

Additionally, a more "hawkish" speech from Fed Chair Jay Powell yesterday signaled a shift from his earlier "dovish" stance on May 1. Referring to the Q1 inflation results, Powell mentioned that the higher-than-expected figures indicated the need for patience to let restrictive policies work. “We did not expect this to be a smooth road,” he stated. “But these [inflation results] were higher than I think anybody expected. What that has told us is that we’ll need to be patient and let restrictive policy do its work.”

Despite this, there was some positive news from the April Producer Price Index (PPI) report in the US, which showed a 0.5% increase for final demand PPI month-over-month, alleviating some worries about persistent inflation in components of the Personal Consumption Expenditures Price Index (PCE PI). A notable decline in airline passenger services prices (-3.8%) and well-behaved inflation in healthcare-related components, which directly influence the PCE PI, were encouraging. However, inflation in portfolio management services was high (+3.9%).

Interpreting the Data

The April PPI results were unusual in that they preceded the Consumer Price Index (CPI), giving insight into the same month’s PCE PI before the CPI report. This might diminish the CPI report's market impact, but today’s April CPI will still be crucial for discerning the Fed's stance ahead of the June 12 Federal Open Market Committee (FOMC) meeting. The consensus for April core CPI is at 0.3%, but relief might come if rents, a significant inflation driver in Q1, show a decline.

Should rents for Owners' Equivalent Rent (OER) and primary residence decrease below 0.4%, it would suggest the recent surge in rent inflation is dissipating. Downward pressure could also come from used cars and airline fares, both showing significant price reductions. Rising financial stress among borrowers could contribute to downward pricing pressure in new cars, with auto loan delinquencies at late-cycle levels. Conversely, high auto insurance premiums could have an outsized effect on core CPI if they remain elevated.

New York Stock Exchange
New York Stock Exchange© Getty Images/Michael M. Santiago

Fed Policy Implications

From a policymaking perspective, even if the core CPI aligns with the consensus at +0.3%, it would still be deemed "high." This would lead to a slight easing in three-month annualized inflation but not enough to signal a significant shift. The six-month annualized core CPI inflation rate might even show a slight acceleration, maintaining pressure on the Fed to keep the policy rate steady.

The Fed requires more substantial evidence of PCE inflation moving back to the 2% target before considering rate cuts. This necessitates consistent low inflation prints in both CPI and PCE PI, especially in broad-based measures like the trimmed mean CPI and PCE PI. Therefore, a single 0.3% core CPI print won’t be sufficient to prompt a policy change, and the Fed might wait well beyond September before considering a rate cut.

Impact on the USD

The USD has softened in May due to weak US headline data, including non-farm payrolls and services PMIs. This suggests a skew towards a weaker USD today. However, the persistently high inflation in Q1 and the improbability of a Fed rate cut in June or July might lead to a market overreaction to a downside core CPI print today. A strong CPI print might not significantly alter the status quo, making a downside print more impactful for front-end rates and the USD.

Despite potential short-term USD weakness, the Fed's cautious tone might prevent any sustained trend reversal. Recent Fed speeches, including Powell's, have maintained a more hawkish stance, indicating a likelihood of waiting until 2025 before starting an easing cycle. This view contrasts with the market’s expectations, which forecast rate cuts beginning in the second half of 2024.

Given the Fed’s likely more hawkish stance compared to the ECB, BoE, and BoC, the EUR/USD could still fall to 1.05 by the end of June. However, if global growth continues to strengthen, especially in China, it might counterbalance any benefit to the USD from monetary policy divergence. The USD's strength or weakness will largely depend on whether the US maintains its lead position in a potentially weak global growth environment.