Persistent inflation challenges FED. Interest rates are on hold until September
Inflation in the USA once again turned out to be higher than expected. According to ING analysts, the FED will maintain interest rates at their current level until September, a shift from the previously discussed June. "Currently, the market gives about a 20 per cent chance of such a scenario happening," writes Łukasz Zembik from Oanda TMS Brokers.
The March CPI inflation reading in the USA was 3.5% annually, an increase from 3.2% in February. The market consensus had assumed the indicator would settle at 3.4% year over year. Inflation in the United States has been higher than expectations for the third consecutive month. These data prompt experts to comment on possible further Fed decisions regarding interest rates.
Inflationary pressure in the USA is rising
As pointed out by Łukasz Zembik from Oanda TMS Brokers, inflationary pressure has recently increased and remains high, with "services leading the way, reflecting higher wage costs." The expert notes that the market valuation of the likelihood of the Fed's first rate cut in June "has definitely decreased. The market currently gives about a 20 percent chance of such a scenario happening."
Zembik emphasizes that the Fed certainly pays a lot of attention to core measures, which are decisive for the underlying trend. "These signal that inflationary pressure is rising. In each of the last three months, the month-to-month dynamics was 0.4 percent, which means that during this period, prices were rising at an annual rate of 4.5 percent – that's definitely higher than the Federal Reserve's target," assesses the analyst.
Service costs and higher wages are responsible for the increase
According to the expert at Oanda TMS Brokers, the increase in inflation is mainly due to the prices of basic services, including rents, which again saw high increases in March. "Other services also increased, a consequence of the labor market situation or more precisely, resulting from wage increases," comments Zembik.
The analyst points out that high readings of core and nominal inflation "will not go unnoticed by the American central bank." In his view, the Fed has received a package of data that may cause greater uncertainty about achieving the inflation target permanently.
Let's recall that the last March forecasts by the Fed indicated that the personal consumption expenditure deflator (PCE index), to which the mentioned target refers, would be 2.4 percent and 2.6 percent (core) on an annual basis - reminds Zembik.
Weakness of gold, the dollar, and Wall Street
High inflation readings have also affected the financial markets. Zembik notes that the EUR/USD exchange rate made a decisive move down and reached the level of last week's low around 1.0730. "The strength of the dollar caused temporary weakness in gold. At one point, an ounce cost 2320 USD (about £1,900), but the price is currently 20 dollars higher," reads the analyst's comment.
The expert at Oanda TMS Brokers also notes that the Wall Street stock indexes are still in a corrective downward phase. "The Dow Jones set new lows, which have been the lowest since mid-March. The extent of the declines is now moderate and still does not send clear signals of a trend change," summarizes Łukasz Zembik.
Service costs push the index higher
Experts from ING Bank Śląski also commented on the latest data about inflation in the USA. Their analysis notes that the March reading of the consumer price index (CPI) was unexpectedly disappointing.
As ING analysts emphasized, although the key monthly reading of core inflation (approximately to the thousandths 0.359% month-on-month) was not far off rounding to 0.3%, it was still twice as high as the average needed to achieve the Federal Reserve's inflation target of 2%.
The analysts point out that every month, the prices of transport services strongly increased (by 1.5%, including a 2.6% increase in the prices of motor insurance and a roughly 1.7% rise in the cost of car maintenance), medical services (0.6%), or housing maintenance (0.4%). Meanwhile, the prices of used and new cars, as well as the prices of recreation and airline tickets, slightly decreased.
First rate cut in September?
"Expectations for the easing of heightened inflationary pressure from the start of the year did not materialize, which distances the prospects of Fed rate cuts and led to a pricing down of bonds in the USA and other markets," reads the ING analysis.
Economists from the bank note that while on Monday, market instruments priced a Fed interest rate cut of 25 basis points at the meeting on June 12 with almost a 50% probability, now it is just under 20%, and only two cuts are priced by the end of the year.
According to ING analysts, starting the cycle of cuts will require easing the labour market situation and a slowdown in inflation.
We expect this may only happen by summer, which - in our opinion - will enable the first cut in September and no more than three in the entire year of 2024 - predict the experts.
High inflation and sustained interest rates may also have political consequences. In an election year, President Biden, seeking re-election, would certainly like to have something to boast about to his voters.
