Inflation Readings Complicate Rate Cut Timing For Markets

Stocks and bonds were lower for the week as unfriendly inflation readings added to economic uncertainty. More economically sensitive parts of the stock market, like the Russell 2000 small-cap stocks, and interest rate sensitive sectors, like banks and real estate, were the hardest hit.

The 10-year and 2-year U.S. Treasury yields rose sharply to 4.3% and 4.7%, respectively. The swift rise in yields caused the Bloomberg U.S. Aggregate Bond index to plummet by 1.2% for the week.

Consumer inflation (CPI) came in higher than expected last week at a 3.2% year-over-year pace. Perhaps more importantly, services inflation remains elevated and sticky. The supercore measure of services inflation, which removes the distortion from the overstated government measure of rent inflation, held steady at 4.3% year-over-year.

Adding to the inflation concerns were producer prices (PPI), which also came in higher than expected last week. While the absolute level of 1.6% year-over-year wouldn’t typically raise eyebrows, much of the improvement in consumer inflation has been from goods and energy disinflation. So, a reverse in the trend of producer prices could be a prelude to upward pressure on the CPI.

The Cleveland Fed’s estimate of March consumer inflation rose to 3.3% year-over-year last week.

While recent monthly job reports have been noisy with soft spots under the surface, the most high-frequency measures of the health of the labor market do not signal any significant deterioration. Wage pressures will likely keep services inflation elevated if the job market remains resilient.

In reaction to the higher inflation readings, markets have now priced in a 60% chance of a Fed rate cut in June, down from almost 100% in the prior week. Odds now favor a June or July start to the Federal Reserve’s short-term interest rate cuts. Fed Fund futures are looking for three cuts of 25 basis points (0.25%) in 2024, down from four the previous week.

The Federal Reserve meets on Wednesday with no change in monetary policy a virtual certainty. While the outcome of the Fed meeting will contain no surprises, the comments from Fed Chair Powell will be parsed for clues as to how critically he views the recent inflation data. This meeting also includes Fed forecasts and the dot plot to add to the evidence to predict the timing of future monetary policy moves. Given the sharp reaction from bond yields last week, bonds and interest rate-sensitive stocks could be particularly volatile around Wednesday’s end of the Fed meeting.