Stuck Between a Rock and Soft Inflation Data

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The April Consumer Price Index (CPI) report released Friday, May 12th demonstrated just how difficult it is for policy makers to accelerate the pace of interest rate increases. While the overall CPI was in line with expectations – +0.2%, the Core CPI (excluding food & energy) showed the weakest year over year reading since 2015. The softer readings along with the fact that many commodity prices (including crude oil) have been trending down during the first part of the year and are now approaching the levels of a year ago mean the contributions to higher prices may have run their course for the present and may, in fact, begin contributing to lower inflation readings for the foreseeable future.

The chart below shows the behavior of both the Consumer Price Index and the Personal Consumption Expenditure Deflator – The Fed’s most watched measure of inflation.  This chart shows just how difficult it has been for inflation to move above the Fed’s 2% target.  This is the case even after eight years of economic expansion and an unemployment rate approaching historic lows.

In addition to softer than expected inflation readings, Retail Sales for April also fell short of expectations although the March numbers were adjusted upward which should help push final estimates of 1Q GDP higher than the initial reading.  Following the CPI and Retail Sales data, US Treasury yields declined 2-5 basis points (0.02 – 0.05%) reflecting the downside surprises in the April readings.

While it is still widely expected that Central Bank policy makers will raise short-term rates by another 0.25% at the June meeting,that likelihood has diminished somewhat. And, based on this most recent data, could mean the next rate increase may not occur until the August meeting. From a longer-term perspective, we continue to believe that the US economy is in a benign interest rate environment that is underpinned by an aging population, a large and growing public debt burden and real GDP growth that will likely remain near the 2% range.