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Market Jitters as Inflation Persists: Rate Cuts on Hold

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Inflation data released Wednesday dealt a blow to hopes of an early interest rate cut by the Federal Reserve. The core Consumer Price Index (CPI), a key measure that excludes volatile food and energy prices, defied forecasts for a third consecutive month. It rose 0.4% compared to February, and remained at 3.8% year-over-year. This persistent inflation suggests price pressures are not subsiding as quickly as expected, pushing potential Fed rate cuts to later in 2024.

Despite the Fed’s aggressive interest rate hikes, recent data paints a concerning picture. The core inflation gauge, favored by economists for its stability, keeps exceeding expectations. This month’s core CPI rose 0.4% compared to last month, and remains unchanged at 3.8% year-over-year. In contrast, the overall CPI, which includes volatile food and energy prices, reflects a sharper 0.4% monthly increase and a 3.5% annual rise. This data suggests inflation is more entrenched than initially anticipated, and the Fed may need to maintain high interest rates for longer to curb price pressures, even with a robust labor market fueling consumer spending.

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Financial markets reacted with a jolt to the disappointing inflation data. Treasury yields and the dollar surged, reflecting investor anxiety about prolonged high borrowing costs. Stock market futures plummeted, anticipating a potential slowdown in economic growth. Swaps traders also adjusted their bets significantly, slashing expectations for Fed rate cuts in 2024.

“June rate cut? Don’t even think about it,” declared David Kelly, a top strategist at JPMorgan, summarizing the sentiment on Wall Street. The data confirmed stubbornly high inflation, with core CPI exceeding forecasts for the third consecutive month. This persistent price pressure, combined with a strong labor market, pushes potential Fed rate cuts further down the road in 2024.

What’s driving inflation? A cocktail of factors. Gasoline and shelter costs, the biggest contributors to the overall CPI increase, continue their upward climb. Additionally, car insurance, medical care, and apparel all saw price hikes. While falling prices for new and used cars offered some temporary relief, it wasn’t enough to offset the broader inflationary trends.

The picture gets even more concerning when we look beyond food and energy. Excluding those categories, service sector inflation is at its highest level since April 2023. This broad-based inflation presents a challenge for the Fed, as their preferred gauge, the PCE price index, doesn’t weigh shelter costs as heavily as the CPI. While the PCE is closer to the Fed’s 2% target, the recent data suggests inflation may be more entrenched than anticipated.

With one more PCE report and another producer price index update on the horizon before their May meeting, the Fed is likely to hold off on any rate cuts. As Kathy Jones, a strategist at Charles Schwab, points out, persistent inflation in the service sector leaves little room for the Fed to loosen its grip on monetary policy.

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