News & analysis

After March’s inflation report led traders to price out Fed rate cuts ahead of December’s Fed meeting and even fret over the prospects of no cuts from the US central bank in 2024, the discourse in markets has once again shifted.

Investors are now becoming more comfortable with the prospect of two rate cuts from the Fed this year, in September and December respectively, after Chair Powell effectively ruled out further rate hikes from the Fed earlier this month, instead projecting confidence that rates at current levels will eventually bring inflation back to target if maintained for a sufficient period, before April’s payrolls report reflected a deceleration in the pace of employment and wage growth.This more dovish outlook for Fed policy has been further boosted by today’s release of April’s inflation data, which showed core price pressures cooling from an average pace of 0.37% in the first quarter to just 0.29% at the start of Q2.

More significantly, however, is the fact that the deceleration in core price pressures was broad-based.

Core goods inflation fell outright in unrounded terms (-0.11% MoM), while the pace of core services also cooled notably from an average rate of 0.55% in Q1 to just 0.41%. Moreover, the Fed’s favoured supercore measure, which removes shelter components from core services, also exhibited strong disinflationary progress as it slowed by more than a third from its first quarter average to 0.42% last month. This saw the 3-month annualised rate cool by 1.83 percentage points to just 6.35%, essentially reversing the acceleration exhibited over the course of the first quarter.

That said, while the renewed disinflation progress will be warmly received in Washington just weeks after policymakers were fielding questions over the risk of further rate hikes, inflation remains too high for the Fed in level terms, meaning there remains ground to cover before the Fed can begin to cut rates.Today’s data can therefore be viewed as a potential turning point in the US inflation trend, but one that remains subject to confirmation.

Progress in April’s inflation report saw markets further converge on our base case for the Fed to cut once in September and then again in December

The resumption of disinflation progress remained  apparent when digging through the details of today’s report too. Food inflation was a decent drag on headline price growth, rising just 0.02% MoM in April, while vehicle prices also dropped significantly. New vehicle prices fell by -0.45% MoM and used trucks by -1.38% MoM, with the latter statistically significant and following a -1.1% decline in March. Admittedly, apparel was a large upside contributor to inflation last month, rising 1.2% MoM in April, but alongside the energy index which also rose 1.1% (with gasoline specifically rising 2.8%) and motor vehicle insurance up 1.8% as it continued to play catch up with past increases in vehicle and repair prices, there were only a limited number of notable upside contributors amongst a series of components that are otherwise now moving in the right direction.

Other upside contributors such as medical care services are much less concerning, with the 0.46% MoM rise in prices for this component in April a result of methodology changes.

Even shelter inflation, which has proven distinctly sticky over this cycle, showed further signs of disinflation progress. Owners’ equivalent rent (OER) nudged down a fraction, albeit the 0.42% implied increase in prices is virtually unchanged from the 0.44% recorded in both February and March. However, rent of primary residence rose by just 0.35% in April, the lowest monthly increase recorded since August 2021. Crucially, however, the drop in inflation momentum that these details imply was visible in the Fed’s preferred measure of underlying price pressures. Granted, supercore inflation continues to run hot, rising 0.422% MoM, and 6.35% on a 3-month annualised basis, but this is down on the 0.65% and 8.18% recorded for March respectively, suggesting that whilst still elevated, inflation momentum might be easing at the margin.

This provides a welcome relief for policymakers who have seen this reading consistently trend in the wrong direction since the start of 2024.

Core measures of inflation have resumed trending in the right direction for Fed cuts, but remain uncomfortably high in level terms

While today’s data has understandably fed into the markets priors for more Fed easing this year–resulting in an extension in the recent market trends of lower Treasury yields, stronger equities, and a weaker dollar against rate-sensitive currencies–we think it remains too early to shift from our structurally bullish USD stance. Firstly, despite the renewed disinflation progress in April’s data, levels of inflation, specifically in core services, remain elevated above the level that would give the Fed sufficient confidence to cut rates. Moreover, the avenue for these inflation components to cool in a risk positive manner remains narrow. Essentially, for risk assets to rally and the dollar to structurally depreciate, not only does Fed easing need to come back into scope, but it also needs to occur without a corresponding increase in US recession risk. Today’s core retail sales data, which printed at -0.3% in April, highlights how this type of rebalancing can’t be taken for granted, especially if weaker employment conditions start to hamper consumer confidence further.

All told, while today’s data adds to our confidence that the Fed will be able to start cutting rates at a quarterly pace of 25bps from September, we still think it remains premature to interpret this in a dovish manner for the dollar due to the risk of a more sinister downturn in US economic conditions on the one hand, and a bumpier disinflation path on the other. That said, we think the dollar could have further to fall in the coming weeks as investors continue to re-risk portfolios, but we don’t expect current ranges in G10 currencies to be broken until the end of Q2 in any event.

While the dollar slipped further as markets turned more dovish on the Fed’s outlook, the broad dollar index continues to trade well within recent ranges, where we expect it to stay until Q3


Simon Harvey, Head of FX Analysis


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