Flash Insights: March inflation—Yet another reason to delay easing

by Nikhil Mohan, Economist, Franklin Fixed Income

March US consumer prices rose faster than expected. The reacceleration in supercore inflation suggests the strong inflation readings at the start of the year may not have been mere blips. Franklin Templeton Fixed Income Economist Nikhil Mohan expects the Federal Reserve will likely begin rate cuts in September, but inflation trends may affect the timing of the cuts.

On a monthly basis, US headline and core Consumer Price Index (CPI) topped expectations—both rising 0.4%. The core measure has now risen at that pace for three successive months. While the pace of increase remained unchanged at 0.5% for core services (which is still more than double the 2012–2019 average), the pace of increase for the supercore measure (core services excluding housing) accelerated to 0.7%. Transportation, medical and other personal services largely drove the rise.  On a six-month annualized basis, core CPI is now near 4%, while supercore CPI inched above 6% (the highest since October 2022) and has been on an uptrend for the past five months.

Although shelter inflation ticked marginally lower, the pace of disinflation remains painfully slow. Owner-occupied rents saw another 0.4% month-over-month (m/m) increase. For rents on primary residences, there was a slight downshift in the pace of increase. However, the six-month annualized measures are still running well above 5% and closer to 6% on a year-over-year (y/y) basis.

Core goods CPI turned negative once again (-0.2% m/m). This was primarily due to declines in prices for new and used vehicles, auto parts, recreational, and information technology goods. The one silver lining is that, on a y/y basis, core goods inflation has turned increasingly deflationary—running well below its 2012–2019 average.

While energy services has slowed since the beginning of the year, the 0.7% m/m increase is still particularly elevated. The six-month annualized and yearly pace rose to 9.7% and 3.1%, respectively. What’s concerning to us is that there has been increasing anecdotal evidence suggesting that households are having to shell out more for electricity. Utility companies have been aggressively upgrading/expanding the existing grid network and decarbonizing. This cost of expansion and upgradation is ultimately falling on end-users.

As for Federal Reserve policy rate expectations, our base case has increasingly turned toward a September cut and 50 basis points (bps) of cuts in total this year. The March inflation print further reinforces that view. Over the past few months, markets too have inched closer to our view—June and July rate-cut expectations have been trimmed significantly after the latest CPI release, and just about 50 bps of rate cuts have been priced in for the year.¹ However, if inflation were to continue reaccelerating and/or stall at its current pace, we wouldn’t rule out a further delay in rate cuts (beyond September).

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1. Source: CME Group fed funds futures market, as of April 10, 2024. There is no assurance any estimate, forecast, or projection will be realized.