Cooling US inflation keeps July Fed cut in play

As expected, falling used car prices were a continued drag on inflation, while the important shelter component cooled to the lowest m/m reading since last October. Car insurance premiums continued to put upward pressure on inflation, although there was a notable easing in this category compared to the March figure. Headline inflation similarly rose 0.3% m/m, with various components in food and energy prices offsetting each other. The decline in April monthly inflation came despite a further large increases in gasoline prices, which we expect to largely reverse in May. After three months of rising annual headline inflation, the CPI declined by 0.1pp in April to 3.4%. Our conviction in a July rate cut has decreased in recent weeks, with Fed officials emphasising the need for ‘patience.’

Although rate cuts have been priced out by markets, and therefore bond yields have risen somewhat, strength in equities is making overall financial conditions quite accommodative again. Combined with the relative resilience in growth, this lessens the urgency to act in the near-term. The Fed will need increased confidence that inflation will reach its 2% target after the disappointing inflation readings in the first quarter of this year. In order to gain this confidence, the Fed will need to see a further fall in inflation in May-June (see here). Today’s return to CPI disinflation keeps a July start to Fed rate cuts in play in our view. The next crucial hurdle will be the April core PCE data out on 31 May, which is the Fed’s main target for inflation. Typically, PCE inflation is weaker than that of the CPI, although readings in the first few months of the year have been unusually stronger. The PPI data out yesterday, combined with today’s CPI data, suggests PCE inflation is likely to move another leg lower in April. If this plays out, markets are likely to price in an increased probability of a July move.