The Market Likes the CPI Report. Here's Why the Fed Will Want to See More
The central bank won't want to be head-faked by the May data.
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* The May CPI report shows more-than-expected progress on inflation.
* This will spur the market’s expectation for rate cuts.
* The Fed will look at the core CPI pattern over the last year and still want to see more good data for rate cuts to start.
Stock are moving higher following this morning’s May CPI report that showed better-than-expected inflation May figures on a sequential and year-over-year basis across the board. In response, the yield on the 10-Year Treasury has fallen to just below 4.3%, its lowest level since early April.
While the year-over-year headline CPI and core CPI figures ticked modestly lower, the market is likely favoring the prints for the sequential CPI and core CPI that came in at 0.0% and 0.2% for May. Annualizing that core figure implies 2.4% and that has caught the market’s eyes as it suggests meaningful progress compared to the 0.4% figure and its annualized 4.8% for Q1 2024.
The Fed will view this favorably and we do too, but when we look back over the last year, month-over-month core CPI figures hit 0.2% in June and July, moved to 0.3% in August and September, then fell back to 0.2% in October before climbing to that 0.4% level for January-March 2024. This pattern and the need to make sure that inflation has moved down sustainably strongly suggests the Fed will note the progress, but that it will still need to see “more good data” before embarking on a rate-cutting cycle.
We do expect the market to view this in a very positive fashion, hence the early uptick, but how sustained the move is will be determined by the Fed’s tone and dot plot this afternoon. Make no mistake, the May CPI data is encouraging, and it builds the case for a rate cut later in the year, something the Fed is likely to signal, but it’s still a question of whether it’s one or two rate cuts.
That will be determined by what we see in the June, July, and August CPI reports, which will be published well before the Fed’s September meeting. What we see in those reports and other economic indicators will give us greater confidence for when the Fed will start cutting rates. With this afternoon's updated dot plot, we'll look to see if it supports the five rate cuts the market sees occurring between now and September 2025. Our thinking is it will not.
