Investors have received some good news after one popular measure of U.S. consumer prices has increased in line with expectations.
On Wednesday, the Labor Department reported the consumer price index, or CPI, rose 3.4% in April, down from 3.5% in March and in line with the 3.4% gain economists were expecting. On a monthly basis, the CPI was up 0.3% compared to March, below economist estimates of a 0.4% gain.
The CPI reading is the latest indicator that inflation is trending in the right direction, and it could be a signal the Federal Reserve may finally pivot to interest rate cuts soon. The S&P 500 initially traded higher by 0.8% on Wednesday morning following the March inflation report.
The Numbers
The April CPI reading resumed the positive inflation trend after year-over-year CPI inflation jumped from 3.2% in February to 3.5% in March.
Core inflation, which excludes volatile food and energy prices, was up 0.3% on a monthly basis and 3.6% from a year ago. Economists had expected annual core CPI inflation of 3.6% in April.
Other key numbers from the report indicate:
- Food prices were flat month-over-month and up 2.2% compared to a year ago.
- Energy prices were up 1.1% on a monthly basis and 2.6% over the past 12 months.
- Used car prices were down 1.4% compared to March and down 6.9% compared to April 2023.
- Shelter CPI was up 5.5% year-over year in April and has increased at least 5% for 26 consecutive months. The shelter index was the largest factor in the core CPI inflation gain.
The latest CPI numbers come after the Labor Department reported the U.S. economy added 175,000 jobs in April, missing economist expectations of 240,000 new jobs. The Labor Department reported U.S. wages were up 3.9% year-over-year in April, while the unemployment rate increased to 3.9%.
The April CPI reading is a positive datapoint for Americans hoping price deceleration has regained its momentum in an environment of slowing economic growth and elevated interest rates.
Other Significant Numbers
U.S. GDP growth slowed significantly to just 1.6% in the first quarter, down from 3.4% in the fourth quarter of 2023.
In late April, the Commerce Department reported the core personal consumption expenditures, or PCE, price index was up 2.8% in March, in line with its 2.8% year-over-year gain in February. Core PCE is the Federal Reserve’s preferred inflation measure.
Chris Zaccarelli, CFA, chief investment officer for Independent Advisor Alliance, says the relatively good news of a positive CPI reading will likely overshadow Wednesday’s negative retail sales report.
“The good news is that CPI hasn’t reaccelerated and, most importantly, it was less-than-expected month-over-month (e.g. 0.3% vs 0.4%), but the bad news is that consumers seem to be reducing their spending,” Zaccarelli says.
“On balance, we think it’s a positive that inflation is moderating and although a slowdown in spending could turn into a problem for the economy, in the immediate term it takes some pressure off the Fed and that is what has been moving bond and stock markets the past couple of months.”
Why CPI Matters
Inflation has been the Fed’s economic enemy No. 1 since early 2022, and the Federal Open Market Committee, or FOMC, has made aggressive changes to U.S. monetary policy in an attempt to bring inflation down toward its long-term target of just 2%.
From March 2022 through July 2023, the FOMC raised interest rates 11 times, bringing its federal funds rate target range to a 22-year high of 5.25% to 5.5%. The FOMC has also been allowing up to $60 billion in Treasury securities and $35 billion in agency mortgage-backed securities to mature and roll off its more than $7.3 trillion balance sheet per month.
Coming into 2024, investors were optimistic the FOMC could begin cutting interest rates in the first half of the year. Unfortunately, inflation was unexpectedly sticky in the first few months of the year, and expectations for the timing of rate cuts have now been pushed back to the second half of 2024.
How the Fed Is Reacting
The Fed has said it will begin tapering the pace of its monthly balance sheet reductions starting in June. However, investors expect the FOMC will choose to maintain interest rates at their current levels at its upcoming meeting in June.
Fed chair Jerome Powell recently acknowledged the “lack of progress on inflation,” admitting the latest data points have been disappointing.
“We did not expect this to be a smooth road, but these were higher than I think anybody expected,” Powell said.
“What that has told us is that we’ll need to be patient and let restrictive policy do its work.”
According to CME Group, markets are currently pricing in a 97.1% chance the Fed will maintain its current target rate range in June and just a 2.9% chance of a rate cut. The market is also pricing in a 57% change the FOMC will issue two or more rate cuts by the end of 2024.
Is a Recession Imminent?
The Federal Reserve is currently navigating a difficult balancing act of maintaining tight monetary policy to bring down inflation without triggering a U.S. recession.
High interest rates increase borrowing costs for companies and consumers, weighing on economic activity.
Up to this point, the U.S. labor market has been mostly resilient. S&P 500 earnings are also up 5.4% year-over-year in the first quarter, but Wall Street is concerned consumers may not be able to continue to take elevated interest rates in stride.
The University of Michigan Survey of Consumers sentiment index for May fell to 67.4, posting its largest monthly decline since mid-2021. Consumers are growing increasingly concerned about sticky inflation and softer economic growth expectations. Psychology plays a key role in consumer behavior, so the downturn in U.S. consumer sentiment could result in suppressed spending in the months ahead.
How the Stock Market Is Reacting
Growth stocks have historically been sensitive to interest rates because fund managers typically use discounted cash flow models to determine their price targets for them. Future cash flows are considered less valuable when the discounted rate is higher.
Fortunately, growth stocks, technology stocks and the S&P 500 as a whole have mostly taken high interest rates and sticky inflation in stride. Anticipation of a Fed pivot has propelled the S&P 500 to new all-time highs in 2024. The Vanguard Growth ETF (VUG) is up 12.7% year-to-date, while the Technology Select Sector SPDR Fund (XLK) is up 10.3%.
Jeffrey Roach, chief economist for LPL Financial, says consumers have pivoted away from big ticket buying plans.
“The Fed is walking a tightrope as they balance both mandates of price stability and growth. Although it’s not our base case, we do see rising risks of stagflation, a concern the markets will have to deal with, in addition to the impacts from the presidential election,” Roach says.
What’s Next?
In addition to its June interest rate decision, investors will be monitoring the Federal Reserve’s commentary on the economy at its upcoming meeting on June 11 to 12. The Fed will also be releasing its updated economic projections.
Investors will be focused on how many interest rate cuts the FOMC expects in 2024, as well as any potential changes in its inflation and economic growth outlook.
Investors will likely look for hints about the FOMC’s intentions when it releases its minutes from the committee’s previous meeting on May 22.
The Fed will get one last key inflation reading on May 31 when the Bureau of Economic Analysis releases its April core PCE reading. The FOMC will also be watching to see if U.S. labor market conditions deteriorate further when the Labor Department releases its May jobs report on June 7.
Skyler Weinand, CFA, chief investment officer at Regan Capital, says the FOMC is not out of the woods quite yet.
“Wednesday’s softer-than-expected CPI print gives the Federal Reserve a tad bit of breathing room to potentially cut rates as early as September,” Weinand says.
“We’re still a far cry from the Fed’s desired 2% inflation level and the economy remains strong, so we’ll need a few more weak inflation prints to give the Fed the green light on lowering rates.”
