Can the March CPI Data Necessitate a May Interest Rate Hike by the Fed?

Inflation in March showed signs of cooling off, with headline inflation up only 0.1% m/m and 5.0% y/y due to lower energy prices and favorable base effects. The y/y increase was a drop from last month’s 6.0%. Meanwhile, core inflation held steady, rising 0.4% m/m and 5.6% y/y, with shelter being the main contributor to overall inflation. However, excluding shelter, headline CPI would have fallen by 0.2% m/m.

The Federal Reserve (Fed) is keeping a close eye on two key concerns: wage growth and core services excluding shelter. Despite being overlooked, both of these areas are showing signs of progress. While average hourly earnings peaked at 5.9% y/y in March 2022, they have since fallen to 4.2% y/y and have been eroded by higher consumer inflation for 24 consecutive months. However, not all workers have benefited equally from higher wages, while all consumers are impacted by higher inflation, leading to reduced spending power.

There are also signs of further cooling in the labor market. According to a survey of small business owners by the National Federation of Independent Business (NFIB), there are fewer plans to fill open positions or create new jobs over the next three months. Moreover, the share of firms reporting raising compensation has steadily fallen after peaking in January 2022.

Transportation services are a significant contributor to core inflation, with leased cars and trucks alone accounting for 1 percentage point of the y/y growth and motor vehicle insurance accounting for 1.5 percentage points. Higher labor costs have impacted both the vehicle repair business and auto insurance, leading to higher input costs passed on to consumers. However, as supply chains have normalized, used vehicle prices have fallen considerably, and new vehicle prices have moderated. As a result, auto businesses may not need to raise prices at an elevated pace, leading to an anticipated decline in these services prices.

The “stickiness” attributed to core services may largely reflect the lingering effects of supply chain issues, where Fed policy has little impact. While recent data shows a disinflationary trend, the Fed may still opt for an additional 25 basis point rate hike at its May meeting in an effort to control inflation. However, this may be the last hike for now.