The latest consumer price index figures from the US show that inflation has continued to cool, giving the Federal Reserve the opportunity to take a break from interest-rate hikes this week. This offers indications that a full stop might be forthcoming. The index rose 4% in May this year, from the same month a year earlier. This marks the slowest increase since March 2021. Core services inflation, which excludes housing and is considered a key indicator by many forecasters for the overall outlook, also dropped to its lowest level in 15 months. This is good news for the Fed, as the officials convene for a two-day policy meeting. Tuesday’s data was as expected and, while inflation does remain above the Fed’s 2% target, the central bank is most likely going to opt against raising interest-rates on Wednesday. This decision may also lead to an extended pause.
According to Jamie Cox, managing partner at Harris Financial Group, “This CPI report is everything the Fed needs to pause — there is deflation and/or disinflation in every category. If this trajectory holds in June, the need for further tightening is behind us.” The report on the figures led investors to reduce the probability of a rate hike this week, and stocks rose. However, the likelihood of another rate increase in July remains slightly above 50%, according to prices from overnight index swaps.
Core inflation, which is measured by excluding food and energy and is viewed by the Fed as the best gauge of underlying price pressures, has remained persistently high. The BLS found that those prices rose 0.4% for the third consecutive month, which is around double the pre-pandemic rate. Nonetheless, under the surface, the details were somewhat encouraging. It was rising used-car prices that mainly prevented the core measure from slowing in May. Leading indicators compiled by the private sector suggest that such prices are set to decline soon. Rents, which form the largest weight in the index, also posted monthly gains that were smaller than seen for much of the past year.
“We expect a more pronounced slowdown in core inflation in the coming months,” wrote Wells Fargo & Co. economists Sarah House and Michael Pugliese in a report. “That said, directional progress should not be confused with mission accomplished.” Fed officials prefer to look at an even narrower category of core inflation, which is services excluding housing, to analyze the trajectory of the most stubborn price pressures. Bloomberg estimates show that this metric increased 0.2% over the previous month, in line with pre-pandemic trends. In comparison, it rose 4.6% from a year before, indicating ongoing moderation after last year’s peak.
Several members of the Fed policymaking committee, including Chair Jerome Powell, have indicated that they prefer to avoid raising rates at the policy meeting on June 13th-14th. They do, however, plan to leave future tightening options open. Even if the Fed does raise rates, it is likely to resist cutting rates anytime soon. Swaps indicate that investors have lowered the probability of a rate cut at the end of this year.
Currently, most economists agree that the bank will not alter rates on Wednesday, but the subsequent CPI report in July will be critical in determining what comes next at its following meeting in a few weeks. “Such rapid headline disinflation will make it harder for the Fed to justify raising rates again, but we can’t rule out a July hike yet,” wrote Ian Shepherdson, chief economist at Pantheon Macroeconomics in a note. “Our base case remains that the Fed is done. But it will be close.”