What The Fed Will Look For In May’s Inflation Numbers

Inflation continues to be the U.S. Federal Reserve’s focus, but for how much longer? On May 10 we’ll get U.S. Consumer Price Index data showing inflation trends for the month of April. The latest nowcasts from the suggests that inflation will come in at just over 5%, showing that inflation is down from its 2022 peak, but nonetheless well ahead of the Fed’s 2% annual goal.

This data will come after the Fed meets earlier in May to set rates, when a 0.25-percentage-point hike is broadly expected, so it will inform the Fed’s subsequent meeting on June 13-14. Fed officials continue to stress that inflation is running too hot and the upcoming CPI report may not change their view. Still a path to a lower rate of U.S. inflation is becoming much clearer.

Food and Housing

Housing costs are pivotal to the CPI report. Many prices which surged have stabilized or even fallen. Food costs, which were a big concern, were flat month-on-month in March, within that, food at home costs declined.

In contrast CPI shelter costs rose 0.6% month-on-month for March, with shelter making up the largest component of the index. Ironically, most industry sources suggest that home prices are now actually falling year-over-year. Yet the way the CPI calculate shelter costs it’s more of a lagging indicator. When and if shelter costs start to moderate in the CPI numbers it should be sufficient to bring inflation much closer to the Fed’s goal.

Other Inflation Data

On May 11, the day following the CPI release, we’ll get Producer Price Index inflation, which measures wholesale prices. This series showed falling month-on-month prices for March with annual price increases running at below 3%. This is often regarded as leading indicator for CPI, so falling prices here would continue to be an encouraging sign for lower U.S. inflation.

Then a further data point on inflation will come on May 26 when the Personal Consumption Expenditures Price Index is released, which is considered the Fed’s preferred inflation metric.

Beyond Inflation

Assuming inflation continues to trend down into the summer, then other economic releases may become more important to the Fed’s decision making. In recent months inflation has been so high that the Fed was unable to look past it, especially as the remainder of the U.S. economy performed relatively well.

Now that maybe changing, the housing market is weakening, banks have come under stress and there are signals a U.S. recession could occur. This is why the markets expect the Fed will have to move on from the inflation fight later in 2023, which appears to be mostly won, and focus on potential risks to employment from weaker economic growth. That’s why interest rate futures see the Fed moving to cut rates over the coming months, after an expected hike in early May.

Upcoming inflation data is expected to be well-received by the Fed and markets, especially if shelter costs start to turn in the CPI series and PPI pricing continues to soften. However, increasingly it may be employment data that gets the Fed’s attention from here, if the economy starts to weaken as fixed income markets are implying.