Consumer prices expected to remain stable as Fed weighs ‘bumpy’ inflation impact on rate path

On Wednesday, investors will digest one of the most important data points that will shape future Federal Reserve interest rate policy: May’s Consumer Price Index (CPI). The inflation report, set for release at 8:30 a.m. ET, will come just ahead of the central bank’s policy decision at 2 p.m. ET. It’s expected to show headline inflation of 3.4%, matching April’s annual gain in prices, according to estimates from Bloomberg. Over the prior month, consumer prices are expected to have risen 0.1%, a deceleration from April’s 0.3% month-over-month increase. That would also be the smallest month-over-month rise since October 2023. A decline in energy prices will likely contribute to further downward pressure on headline CPI, according to Bank of America. “Energy prices likely fell in May on a seasonally adjusted basis owing to a decline in gasoline prices. This likely was a relief for consumers after gas prices had increased in April and March,” BofA economists Stephen Juneau and Michael Gapen wrote in a note to clients last week. “With crude prices moving lower, gas prices are likely to continue to decline in the near-term.” On a “core” basis, which strips out the more volatile costs of food and gas, prices in May are expected to have risen 3.5% over last year — a slight slowdown from the 3.6% annual increase seen in April, according to Bloomberg data. Core prices are expected to have climbed 0.3% month over month in May, matching April. Core inflation has remained stubbornly elevated due to higher costs of shelter and core services like insurance and medical care. But BofA expects those categories “to make a very small step in the right direction.” “Shelter inflation was likely a little firmer this month owing to an increase in lodging away from home prices,” said Juneau and Gapen. “However, core services ex shelter should show some moderation as we look for softer increases in several service categories.” Over time, the economists said they “expect to see more notable progress on services inflation,” thanks to moderations in motor vehicle insurance, rent, and owners’ equivalent rent. Owners’ equivalent rent is the hypothetical rent a homeowner would pay for the same property. The team at Goldman Sachs, led by Jan Hatzius, agreed “further disinflation” remains in the pipeline this year, citing “rebalancing in the auto, housing rental, and labor markets.” Still, “we expect offsets from catch-up inflation in healthcare and car insurance and from single-family rent growth continuing to outpace multifamily rent growth.” Goldman anticipates year-over-year core CPI inflation of 3.5% and core PCE inflation of 2.8% in December 2024.

To cut or not to cut?

Inflation has remained stubbornly above the Federal Reserve’s 2% target on an annual basis. And even though this CPI report won’t have an outsized effect on the looming Fed decision, the timing has perhaps added even more spectacle around its release. Fed officials have categorized the path down to 2% as “bumpy,” while other recent economic data has fueled the Fed’s higher-for-longer narrative on the path of interest rates. On Friday, the Bureau of Labor Statistics showed the labor market added 272,000 nonfarm payroll jobs last month, significantly more additions than the 180,000 expected by economists. Wages also came in ahead of estimates at 4.1%, although the unemployment rate rose slightly to 4% from 3.9%. Notably, the Fed’s preferred inflation gauge, the so-called core PCE price index, has remained particularly sticky. The year-over-year change in core PCE, closely watched by the Fed, held steady at 2.8% for the month of April, matching March. “If the report is in line with our expectations, we would maintain our expectation for the Fed to cut one time this year in December,” BofA said. “We feel it is unlikely that inflation data will soften enough over the coming months to enable the Fed to cut before December. The main risk to earlier cuts is a faster slowdown in employment growth than we project or a sharper deceleration in shelter inflation.” Investors now anticipate a range of one to two 25-basis-point cuts in 2024, down from the six cuts expected at the start of the year, according to Bloomberg data. As of Tuesday, markets were pricing in a roughly 48% chance the Federal Reserve begins to cut rates at its September meeting, according to data from the CME Group.