Inflation beats expectations in the US, September rate cut eyed

Inflation in the USA has once again exceeded expectations. Analysts from ING believe that the Federal Reserve (Fed) will keep interest rates stable until September, a delay from the previously discussed June. "Currently, the market estimates about a 20 percent chance for this to happen," says Łukasz Zembik from Oanda TMS Brokers.

The USA's March Consumer Price Index (CPI) inflation rate was 3.5 percent year-over-year, up from 3.2 percent in February. This was higher than the market consensus of 3.4 percent. This marks the third consecutive month where inflation in the United States has surpassed expectations, leading analysts to speculate about the Fed's next moves regarding interest rates.

According to Łukasz Zembik from Oanda TMS Brokers, "inflationary pressures have been intensifying and remain elevated, with services, driven by rising wage costs, leading the charge." He notes that the likelihood of the Fed cutting rates in June has significantly decreased, with the market now giving only about a 20 percent chance for such an outcome. Zembik highlights that the Fed pays close attention to core inflation metrics, which indicate underlying trends. "For the past three months, the month-to-month inflation rate has been 0.4 percent, which translates to an annual rate of 4.5 percent—well above the Fed's target," he observes.

The surge in inflation can largely be attributed to the cost of essential services, including rents, which have seen significant increases in March, as per the analysis from Oanda TMS Brokers. "Other services have also become more expensive, which is tied to the labor market dynamics, particularly wage growth," notes Zembik. He stresses that the Fed will undoubtedly take note of the high readings of both core and headline inflation, indicating it might reassess its strategy for achieving its inflation targets.

"Remember, the Fed's March projections expected the personal consumption expenditures price index (PCE index) to be around 2.4 percent and the core measure at 2.6 percent year-over-year," Zembik reminds us.

The high inflation figures have also left their mark on the financial markets. Zembik points out a significant dip in the EUR/USD exchange rate to last week's low of around 1.0730. "The strengthening dollar contributed to a momentary dip in gold prices, with an ounce dropping to 2320 USD, though it has since recovered by 20 dollars." Meanwhile, he observes a downward correction in Wall Street indices, with the Dow Jones reaching its lowest point since mid-March. However, the decline has been modest, without indicating a clear shift in the market trend.

ING Bank Śląski's experts have also shared their insights on the latest US inflation data. They noted that the March CPI was disappointing. According to their analysis, even though the core inflation's monthly figure was close to 0.359 percent—which could round down to 0.3 percent—it's still double what would be necessary to hit the Fed's 2 percent inflation target. They highlighted sharp increases in transportation services, medical services, and housing maintenance costs, while noting slight decreases in the prices of cars, entertainment, and airline tickets.

Expectations for a decline in inflationary pressures early this year have not come to fruition, leading to a reevaluation of the likelihood of Fed rate cuts and causing bond prices to drop in the USA and abroad. "At the beginning of the week, the market had almost a 50 percent expectation for a 25 basis points rate cut in June, but now that probability has fallen to just under 20 percent, with only two cuts expected by the year's end," reports ING. The analysts believe that starting the cycle of interest rate cuts will require a cooled labor market and reduced inflation rates.

"We anticipate this might only occur by summer, allowing for the first rate cut in September and no more than three throughout 2024," they predict. The persistent high inflation and steady interest rates could also have political ramifications, especially for President Biden, who is up for re-election and keen on presenting positive economic achievements to voters.