Market to Federal Reserve: Hold, Wait, Pause, Stop, Hesitate

The Consensus is In: The Federal Reserve Will Not Raise Rates Tomorrow

Following a lower-than-expected May inflation report, it is highly likely that the Federal Reserve will maintain interest rates in the 5-5.25% range. CME’s FedWatch tool shows futures markets predicting a 94% probability of rates remaining unchanged this week, compared to 79% yesterday.

However, it is important to examine the specific details of the inflation data. While overall inflation was impacted by lower energy costs and a slowdown in food inflation, shelter and used-car inflation remained strong. This mixed data explains why the initial rally in Treasuries, prompted by the CPI report, eventually fizzled out.

It is crucial to analyze individual sectors to gain a deeper understanding of the inflation drivers. Let’s take a closer look at a few sectors with the assistance of this chart from Wells Fargo:

1) Rents: May’s shelter costs rose by 0.5% compared to the previous month. This increase aligns with predictions made by Goldman Sachs economists earlier in the week. On the other hand, hotel prices experienced a significant jump, with lodging away from home rising 1.8% on a seasonally adjusted basis and 2.6% unadjusted. Overall, shelter inflation played a significant role in the month’s CPI increase.

2) Used cars: Seasonally adjusted inflation in used cars and trucks remained steady, rising by 4.4% in May, similar to April’s 4.4% increase. Used cars and trucks contributed significantly to inflation for the month, and the recent decrease in wholesale used-car prices has yet to impact buyers. Additionally, car insurance rates increased by 2% on a seasonally adjusted basis and 17% over the past year.

3) Food: Grocery prices saw a slight increase of 0.1% in May after a few months of declines. Egg prices, however, dropped by 13% as supply pressures eased, and pork costs decreased by 0.8% from the previous month.

Mixed data like this is likely to reinforce existing biases among investors, according to Jefferies economist Thomas Simons. The housing market and core service prices may suggest a soft landing or immaculate disinflation scenario, indicating that the Fed is achieving its goals without a significant economic slowdown. However, those anticipating a hard landing can point to declining energy prices and continued pressure on housing and core service prices, potentially leading to reduced consumer spending and a looming recession. Simons remains in the hard landing camp and expects the Fed to pause at the upcoming meeting without being forced to raise rates again in the near future.

Michael Feroli from JPMorgan argues that although some figures may offer hope, there has been limited improvement overall. Core PCE is expected to increase by 0.35% in May, remaining unchanged from April.

Wells Fargo’s Sarah House and Michael Pugliese emphasize that directional progress should not be mistaken for mission accomplished. They anticipate a noticeable slowdown in core prices in the coming months as housing inflation peaks and used auto prices decline. Although excluding used autos, core goods inflation is showing signs of easing due to normalization in supply chains and moderating demand. They predict that if core CPI grows at a 3.0%-3.5% annualized rate in the fourth quarter of the year, it will prevent the FOMC from cutting rates until 2024. In the immediate future, today’s data should confirm a pause at the June FOMC meeting with no rate hikes. However, they believe Chair Powell’s press conference and the latest Summary of Economic Projections may indicate the possibility of one more rate hike.