MACRO: A look at US CPI report

US CPI inflation report for March was released at 1:30 pm BST today. Report surprised the market with higher-than-expected values for both core and headline inflation. The data showed headline CPI at 3.5% YoY (exp. 3.4% YoY), and core CPI at 3.8% YoY (exp. 3.7% YoY). The report caused significant movements in the market. Currently, we observe declines of 1.20-1.30% on indices, US bond yields briefly traded at 4.50%, and the US dollar index gained 0.75%. The negative surprise from the report also led to a decline in market expectations regarding interest Fed rate cuts. However, does today's report signify a prolonged return of inflation and a repetition of the 1970s? We invite you to a detailed analysis based on the latest data.

Core and Headline Inflation

The market's reaction to the data was immediate. We witnessed a rapid strengthening of the dollar, as well as drop of US500 and US100 indices below key levels. The catalyst was, of course, the higher inflation data, resulting in a shift in rate cut expectations to 2024. March data also turned out to be higher on a monthly basis, reaching +0.4% (exp. +0.3%) for both CPI and core CPI.

Service Prices

The most problematic sector currently is services. These data are likely the current concern of the Fed. Inflation for services excluding shelter rose to 4.5% y/y, increasing the risk of a second wave of inflation. Considering rental prices, inflation in the services sector (CPI services) rose to 5.3%.

The data was surprising, especially considering the recent lower services ISM readings. However, as seen in the chart below, CPI readings are currently following oil prices higher. The disparity between the data is significant, and to calm the situation in the coming months, we would need to see a decrease in oil prices, which does not seem likely from a fundamental perspective.

The boost in inflation due to rising energy prices was already known. However, an equally strong contribution from other components was surprising. Attention should be paid here to transportation services and healthcare.

Prospects for Rental Prices

The negative surprise from the report comes at a time of declining inflation for rental services on a yearly basis. Although the dynamics remain exceptionally high, the trajectory for the coming months is downward, which should be perceived positively. However, new data for housing prices (Case Shiller), pushed forward by 18 months, have started rebounding, indicating the risk of a return of inflationary pressure in the longer term.

Positive Aspects

If we were to look at the positive aspects, currently, deflationary pressures are aided by both used car prices and food prices. However, current levels are already relatively low, exhausting the potential negative effect in the coming months.

What does the data mean for the Fed?

The market's reaction to the CPI report publication clearly indicates that investors have shifted their expectations for interest rate cuts further into the future. Currently, the first full cut (25bp) is expected in September. Before the CPI report, expectations indicated that the Fed could make such a move as early as June. However, now the Fed is expected to make only 2 interest rate cuts in 2024. To improve the situation, in the coming months, we would need to see lower oil prices, which fundamentals do not indicate, as well as decreasing inflation in the rental housing sector.

In this context, it will certainly be worth observing the next round of comments from Fed bankers, which should shed some light on the outlook for the second half of 2024. However, the situation is not easy, especially considering the strong labor market report from two weeks ago.