Updates - Monetary Policy

US REACT: April CPI Is Soft, But Details Aren’t Reassuring (2)

By Anna Wong (Economist), Stuart Paul (Economist) and Estelle Ou (Economist)
May 15, 2024

(Bloomberg Economics) — OUR TAKE: April’s soft core CPI reading is the lowest yet this year. The good news is that we’re finally seeing disinflation in housing rents, which are on track to follow the downward path we – and probably the Fed – expected. On the other hand, there are lingering signs of a strong inflationary impulse in some categories that are seeing catch-up price gains.

The report will probably add a bit to Fed confidence about disinflation progress — but they’re likely still less confident than they were entering 2024. At least April’s CPI should keep the chances of a July rate cut alive, for now.

  • Headline CPI inflation ticked down slightly to 0.31% (vs. 0.38% prior), with the year-over-year change moderating to 3.4% (vs. 3.5% prior).
  • Core inflation slowed noticeably to 0.29% (vs. 0.36% prior) – close to our expected 0.28% — with the year-over-year rate falling to 3.6% (vs. 3.8% prior).
  • On one-, three-, and six-month annualized bases — metrics Fed officials use to gauge inflation momentum — core CPI rose 3.6%, 4.1%, and 4.0%, respectively (vs. March readings of 4.4%, 4.5%, and 3.9%, respectively). Fed Governor Christopher Waller has indicated he focuses more on the longer-term measures.
  • Taking our CPI projections together with April’s PPI data, it appears the core PCE deflator (due out May 31) will rise 0.247% — below the 0.26%-0.49% range seen in the first three months of the year. That would correspond to a year-over-year core PCE change of 2.8%, the same as March. These estimates are consistent with our projections for the 12-month change in core PCE to slow to 2.7% by mid-year.
  • Energy added 8 basis points to headline CPI inflation. Energy costs increased 1.1% on a monthly basis in April, same as March. Within that, gasoline prices rose 2.8% (vs. 1.7% prior) on a seasonally adjusted basis, partly offset by lower electricity and natural-gas costs.
  • Food prices were flat, as easing food-at-home inflation — driven by lower meat and fruit prices — more than offset the increase in prices of food away from home. Inflation for limited-services meals – which captures higher fast-food prices — accelerated to 0.4% (vs. 0.3% prior). Still, that increase was less than we expected based on our reading of earning transcripts from fast-food chains, which reported raising menu prices 1%-7% after California’s 20% minimum-wage hike for fast-food workers.
  • Core goods prices fell 0.1%, driven by a seasonally adjusted 1.4% decline in used-car prices (vs. -1.1% prior) and 0.4% decline in new car prices (vs. -0.2% prior). We see room for car prices to continue driving disinflation at least through summer.
  • Core services inflation ticked down to 0.4% (vs. 0.5% prior), but remained elevated. The good news is that the long-awaited disinflation in housing rents is happening. Growth in primary rents eased to 0.35% (vs. 0.41% prior), while owners-equivalent rent (OER) rose 0.42% (vs. 0.44% prior) — both readings close to what we expected. Market rents suggest both OER and primary-rent inflation will slow throughout 2024, with annual overall shelter inflation falling to 4.0% by year-end (from 5.6% in April).
  • However, there are still signs of sticky inflation. Car-insurance costs rose 1.8%, on top of March’s sharp increase. Recreation services accelerated to 0.3% (vs. 0.1% prior).
  • Bottom line: April’s CPI report was a step in the right direction. Along with data showing slower hiring, that may keep alive the chances of a July rate cut.

Core Inflation Resumes Slow Downward Trend

Source: BLS, Bloomberg Economics

CPI Implies Core PCE Inflation Will Be Soft

The April core PCE deflator — the Fed’s preferred inflation gauge — won’t be released until May 31, but it can be estimated with decent precision after the CPI and PPI releases. We preliminarily estimate April core PCE inflation was 0.247% (vs. 0.32% prior), with the year-over-year change staying at 2.8%.

If that forecast is correct, then on annualized one-, three-, and six-month bases, core PCE inflation will increase 3.0%, 3.4%, and 3.2%, respectively (vs. 3.9%, 4.4%, 3.0% prior). By these measures, inflation momentum is still running much higher than the Fed’s 2% inflation target.

Fed Chair Jerome Powell’s preferred “supercore” inflation gauge – core services excluding housing rents – should register 0.21% (vs. 0.39% prior). Year-over-year, the indicator likely edged down to 3.4% (vs. 3.5% prior). On one-,three-, and six-month bases, we see the indicator rising 2.6%%, 3.2%, and 4.0% (vs. 4.8%, 5.5%, and 3.8% prior).

Core PCE Softer Than Core CPI, But Will Stick Around 3%

Source: Bloomberg Economics, BLS

Shelter, Energy Boost Inflation as Auto Prices Reverse

Shelter — the primary driver of headline inflation — showed signs of resuming disinflation. Rents rose 0.35% in April (vs. 0.41% prior) and OER rose 0.42% (vs. 0.44% prior). We expect disinflation in shelter to gain momentum in the months ahead as market rents slow.

After accounting for the drag created by the declining cost of hotel stays, shelter contributed approximately 14 bps to monthly headline CPI inflation. Excluding shelter, we estimate core services boosted monthly CPI by 12 bps — down from 17 bps in March.

Energy prices added nearly 8 bps to monthly inflation — same as March — due to the 2.8% seasonally adjusted increase in gasoline prices. The contribution from gasoline was only partially offset by the declining price of piped gas within utilities services.

A 0.7% monthly decline in the price of cars and parts created just more than 4 bps of drag on headline inflation. Almost two-thirds of that drag can be traced to a 1.4% monthly decline in the seasonally adjusted price of used cars and trucks. But the bulk of that decline comes from favorable seasonal adjustment factors — on an unadjusted basis, used-car prices fell a more modest 0.4%. Other core goods exerted upward pressure on inflation, adding just more than 2 bps to the monthly headline measure.

Slower Supercore, Reversal in Autos Allow Inflation to Slow

Source: BLS, Bloomberg Economics

Disinflation Diffusion Takes a Pause

The disinflation process became somewhat less entrenched in April based on our measure of diffusion. The share of core spending categories experiencing outright deflation declined to 38% in April from 42% prior. The share of categories with moderate annualized monthly inflation of 0.0%-2.0% rose to 12% from 11%.

The share of core spending categories with annualized inflation between 2.0%-4.0% decreased to 5% from 6%. But the share of categories with annualized inflation above 4.0% increased to 45% in April from 40% prior.

With deflation becoming less common, and with an increasing share of categories experiencing rapid price growth, diffusion measures will keep the Fed on edge in the months ahead.

Disinflation Becomes Less Entrenched

Source: BLS, Bloomberg Economics

Two Rate Cuts Expected After Core CPI Slowdown

The slower CPI inflation led markets to price in a slightly quicker rate-cut pace for the year. In the 45 minutes after the CPI release, markets were fully pricing in two rate cuts this year — compared to a bit more than 43 bps of cuts a day before the release.

Yields on two- and 10-year Treasuries dropped by 4 and 4.5 bps, respectively. Declining yields sent the dollar index down 0.3%, and boosted S&P 500 futures by 0.5%.

Markets Fully Price Two Rate Cuts This Year

Source: Bloomberg Economics