The Inflation-Quake Sends Tremors Across Wall Street
Was that an earthquake?
The Department of Labor reported that its consumer price index (CPI) rose by four-tenths of a percentage point in March, topping forecasts and matching the February reading. The so-called core consumer price index, which excludes prices of food and energy, also rose by 0.4 percent.
The year-over-year rate came in at 3.5 percent for headline inflation, up from 3.2 percent in February and above the 3.4 percent expected. Core inflation rose 3.8 percent for the second straight month, defying expectations that it would cool.
If you annualize these figures you get a sense of just how high inflation is running. The one month annualized headline CPI comes in at 4.6 and core is running at 4.4 percent.
A lot of economists like to look at three-month annualized numbers to smooth out month-to-month volatility and to get a sense of the trend in inflation. This became particularly popular late last year, when the three-month annual numbers seemed to show that inflation was defeated. The three-month annualized headline CPI increase in November, for example, was 1.7 percent and the core rate was 2.8 percent.
Now things are running in the opposite direction. The three-month annualized rate for headline inflation is 4.6 percent. Core is at 4.4 percent. The victory over inflation that the Biden administration and many on Wall Street were eager to celebrate last year now seems to have been, well, transitory.
Wall Street’s Recent History of Underestimating Inflation
This was the fourth consecutive month of inflation coming in hotter than forecast. Underestimating inflation once or twice is understandable. But doing so consistently month after month indicates a deeper failure of economic analysis and a stubborn refusal to accept the inconvenient reality that inflation has become embedded far above the Federal Reserve’s two percent target.
The CPI report sent shockwaves across Wall Street, rattling markets much as last week’s earthquake shook the Northeast. Stocks tumbled and bond yields rose. The yield on 10-year Treasuries moved up above 4.5 percent, the highest since November. The yield on two-year Treasuries is flirting with five percent, up over 80 basis points since mid-January.
Traders work on the floor of the New York Stock Exchange during afternoon trading on April 9, 2024, in New York City. (Michael M. Santiago/Getty Images)
The market significantly reduced the odds of a rate cut in June and July. The federal funds futures market had been implying around a 60 percent chance of a cut yesterday. After the release of the CPI report, this fell to 17 percent. The odds for a July cut plunged from near 75 percent to 43 percent. The market pricing for total cuts this year fell from three to two.
The persistence of inflation in the March data demolishes the arguments so vociferously made by many Wall Street analysts that the hotter-than-expected figures in January and February were the result of some unaccounted for seasonality or firms implementing annual price changes at the start of the year. That never made much sense because the inflation data is adjusted for seasonality already. Now that the higher rate of inflation has extended into March, it’s clear that the acceleration was not just an anomaly or adjustment oversight.
Powell Gets an Answer to His Bump
In his recent remarks at Stanford University, Fed Chairman Jerome Powell said that “it is too soon to say whether the recent readings represent more than a bump.” While that might have been true a few days ago, it is no longer too soon. This is more than a bump.
At Stanford, Powell also repeated the Fed’s mantra that “we do not expect that it will be appropriate to lower our policy rate until we have greater confidence that inflation is moving sustainably down towards two percent.” The effect of the March CPI data will be to instill less confidence in the view that inflation is on a downward trajectory.
Federal Reserve Bank Chair Jerome Powell speaks at Stanford University on April 3, 2024, in Stanford, California. (Justin Sullivan/Getty Images)
It would be an understatement to say that the details of the report were not reassuring. The so-called “super core” inflation measure (core services excluding shelter), which was recently invented with the intention of showing that inflation really was not all that bad, has lately been doing the opposite. This rose 0.65 percent month-over-month, which annualizes to a stunning 8.5 percent, up from 7.8 percent last month.
Wall Street has put away the childish dream of a June rate cut and is close to capitulating on a July rate cut. Since the Fed will not want to implement its first cut on the eve of the election, the September meeting is likely off the table. That leaves November and December for possible cuts.
The most likely scenario right now, however, is that the Fed does not cut at all this year. It may wind up waiting until March of next year to announce the first interest rate move since July of 2023. But if inflation continues to refuse to bend, that move may be a raise.
