Federal reserve pause is still coming, just not yet

The Federal Reserve’s rate increases are coming to an end, and bond traders are falling over themselves to buy the pause.But the latest inflation data Wednesday suggest that one more hike is probably in store.

The core consumer price index rose 0.4 percent in March from a month earlier, a slight deceleration that put the three-month annualised rate at around 5.1 percent. From the Fed’s perspective, it’s a decent outcome, just not good enough to alter its plan to raise rates by 25 basis points to a range of 5 percent to 5.25 percent when it meets May 2-3; that will most likely be the final hike. With unemployment still running at just 3.5 percent, Fed Chair Jerome Powell sees entrenched inflation as the primary risk to the economy, above and beyond the risk of causing a recession.

It’s a close call, but the March data still had enough worrisome details to keep Powell up at night, especially after breaking down core inflation.

First, there is shelter, which accounts for around 43 percent of the core consumer price index. For methodological and practical reasons, rent inflation in the CPI tends to drastically lag market trends on new leases, which have already shown significant cooling. So while shelter inflation remains elevated, it’s expected to fall over the coming year, albeit sluggishly. In the month-on-month data, rent of shelter rose 0.6 percent in March, the slowest since July 2022 and a welcome inflection point in the data. But Bloomberg Economics expects it will take through the end of 2024 for rents to essentially normalise and cease to buoy inflation.

In other words, the Fed needs disinflation to come from other parts of the basket: core goods such as cars and trucks, and the other core services categories.

Core goods have been a significant deflationary force for months, but that’s becoming less and less true. In 2021, prices of used cars in particular skyrocketed amid pandemic-era supply shortages and robust demand supported by government stimulus checks. The temporary reversal of the used-car bubble helped the Fed for a while, but that effect may be running out of steam. With that, core goods seem to be turning into a neutral force on overall inflation.

That, of course, puts the onus on core services other than housing to help bring inflation down and — no surprise — that’s exactly where the Fed has placed a lot of its focus. The so-called supercore services index rose 0.4 percent in March, and the three-month annualised pace is still about 4.4 percent, well above pre-pandemic norms. That slowed a bit from last month, but Fed policymakers will badly want to see that trend continue if they’re going to refrain from raising rates further.

Clearly, a lot can still change before policymakers meet next month, with the Bureau of Labor Statistics reporting the producer price index Thursday and retail sales due on Friday. The risks of a US recession have increased since a crisis beset Silicon Valley Bank and several peers last month, in all likelihood tightening credit availability across the economy. That risk now clearly rivals the risk of inflation, and Powell seems to be inching toward that conclusion as well. But Wednesday’s report simply wasn’t good enough to get him there any sooner.

Jonathan Levin has worked as a Bloomberg journalist in Latin America and the US, covering finance, markets and M&A. Views are personal and do not represent the stand of this publication.

Credit: Bloomberg