Wall Street embraced the U.S. April consumer-price index, a closely watched inflation gauge published Wednesday, with cautious optimism.
But some Wall Street analysts are worried inflation might not be slowing quickly enough to satisfy the market’s expectation for as many as three interest-rate cuts by the Fed before the end of the year.
U.S. consumer prices increased by 0.4% in April, with core inflation, excluding food and energy prices, also up by 0.4%. On a year-over-year basis, headline CPI declined by 4.9%, falling below 5% for the first time in two years, while core inflation rose 5.5%.
See: U.S. consumer price inflation below 5% for first time in two years
U.S. stocks initially rose in the wake of the data’s release as Wall Street analysts highlighted promising details in the numbers. After a choppy session, the S&P 500 finished Friday up 18.47 points, or 0.5%, at 4,137.64.
PMorgan Chase & Co.
JPM,
Chief U.S. Economist Michael Feroli said the 0.4% increase in core goods last month was mostly driven by a 4.4% surge in volatile used car and truck prices, offering the impression that goods inflation might be worse than it actually is.
Then there was improving “supercore” inflation. Supercore rose by just 0.1% last month, the slowest rate since July 2022.
The data point has become of increasing interest to financial markets since Federal Reserve Chairman Jerome Powell highlighted persistently high service sector inflation during a press conference earlier this year.
Despite these details, and the fact that the headline number of 4.9% was slightly better than economists polled by the Wall Street Journal had expected, market strategists said that the inflation data reaffirmed the gulf between expectations and reality when it comes to how the Fed might react to inflation that has slowed, but remains well above its target of 2%.
Fed funds futures traders expected three interest rate cuts in 2023 as the most likely scenario, an expectation that was little-changed after the inflation data. Meanwhile, expectations that the Fed will leave rates on hold next month increased, according to the CME’s FedWatch tool.
Powell and other senior Fed officials have dismissed the possibility of even a single rate cut before 2024.
“There is a pretty big disconnect,” said Liz Young, SoFi’s head of investment strategy, during a call with MarketWatch. “One of them is going to be wrong. Either the Fed is going to be wrong or the market is going to be wrong.”
“I personally do think we’ll see a cut before the end of the year. But I don’t think we’ll see three.”
The problem with expectations for a rate cut is that the U.S. labor market still appears robust, especially when compared with prepandemic levels. Even if the pace of job creation has slowed somewhat in recent months.
According to data released earlier this month, unemployment remained at 3.4% in April, according to data released by the Labor Department.
For inflation to reach the Fed’s 2% inflation target before the year-end, things would need to change pretty quickly, Matt Weller, global head of research at Forex.com and City Index, told MarketWatch that he thinks this is unlikely.
“Inflation will likely stay above the Fed’s target for at least the rest of the year,” Weller said during a phone interview. “I think the market has gotten ahead of itself pricing in these rate cuts.”
While U.S. stocks swung back and forth between gains and losses on Wednesday, Treasury yields stayed lower, with the 2-year yield
TMUBMUSD02Y,
off by 10 points at 3.904% in recent trade. The U.S. dollar
USDJPY,
was lower against most rivals, falling 0.7% to 134.27 Japanese yen.
These are all signs that the inflation data have bolstered expectations that the Fed is done hiking rates, Weller said.
But looking past the Fed’s June policy meeting, there is another potentially more troubling way that stubborn inflation could spell trouble for the Fed and for markets.
The Fed’s rate hikes have already been cited as contributing to losses and the collapse of several U.S. banks, including Silicon Valley Bank and Signature Bank, while First Republic Bank has been taken over by JPMorgan.
A team of market analysts at Bank of America Global Research is fond of reminding readers that every time the Fed raises interest rates, something “breaks,” forcing the central bank to step back in and provide support for the banking sector.
But the Fed could run into problems if there is a crisis with inflation still so high, said Steve Sosnick, chief strategist at Interactive Brokers, during a phone call with MarketWatch. Sosnick also noted that Wednesday’s CPI number came in roughly in line with expectations.
“We have been conditioned over the past 20 years for the Fed to step in and intervene at the first hint of a crisis,” Sosnick said. “But they didn’t have to reckon with inflation. Now, the hurdle for the Fed to step in is a lot higher.”
Young agreed, saying it would take a genuine catastrophe for the Fed to intervene by cutting interest rates with inflation still so high.
“It would take a real market disaster for the Fed to actually consider cutting rates at this point with inflation still at 5%,” Young said during a call with MarketWatch. “If there was a big shock like that, it would probably take care of the inflation problem.”
Elsewhere in the stock market, the Nasdaq Composite
COMP,
gained 126.89 points, or 1.%, to 12,306.44 on Wednesday. The Dow Jones Industrial Average
DJIA,
meanwhile, fell by 30.48 points, or 0.1%, to 33,531.33.
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