The March inflation read--the March Consumer Price Index (CPI) Summary--spooked the markets this week, which came after two weeks of Fed speakers jawboning that the markets were ahead of the Fed on interest rate cuts in 2024 (i.e., trying to deflate expectations for three to four interest rate cuts this year). We've pointed out some flaws in how CPI is measured in the past, especially as it contemporizes lagged readings/drivers like rent and insurance, drivers that the Fed usually looks through.
We show the stripped reading below as adjusted CPI, which is CPI without shelter, food, energy, used cars, and auto insurance. As shown, this series has been running below 2% since August, with 2% being the Fed’s target. If we assume that the Fed sees 2.5% as “good enough” (they need to begin tapering their restrictive monetary policy well before inflation hits 2%, otherwise it will overshoot to the downside), and subtract adjusted CPI from that figure, we create the red line which is measured on the right-hand side. The red line has been below zero since November. Food-at-home inflation has been the biggest pain for consumers and the Fed; that series is now running even with adjusted CPI as most non-produce items, again moving lower on a month-over-month basis. As to auto insurance, recall insurance is high due to last year’s high cost of replacement vehicles (i.e., used cars and high repair costs). Used car prices are now lower year-over-year by -2.2%.
That said, we think this reading and the market’s “hawkish” reaction is enough for the Fed to “kick the can down the road” from June to July at the earliest for its first rate cut as they have no reason to move earlier given the shorter six-week period between meetings. As shown in the second figure below, the financial markets see less than a 50% chance of a cut at the end of the July meeting.
Source: CME FedWatch Tool
