A shift in sentiment

What a difference a week makes! After last Friday’s strong employment report, markets convinced themselves that the Federal Reserve would continue to wait until it saw weaker jobs growth or slower inflation to cut its federal funds rate. 

Fast-forward to the Consumer Price Index (CPI) report for May. It showed that Inflation slowed: headline prices were unchanged, and the core measure, excluding volatile food and energy, rose only 0.2%. Over the last year through May, consumer prices rose 3.3%, down from 3.4% in April, while core inflation fell to 3.4%, from 3.6%. Overall goods prices were flat, while services prices rose 0.2%. Prices of apparel, new vehicles and airfares all fell, while medical care prices continued to rise. But the trend is clear: core CPI has fallen from 0.4% monthly gains in the first quarter, to 0.3% in April, to 0.2% in May. Markets added back part of another cut, raising the odds of a September cut to over 80%, from about 50% after the jobs report. 

Armed with the May CPI report, the Fed did not change its fed funds rate at its meeting. In its quarterly projection summary, members kept their growth projection stable, at 2.1% this year and 2.0% in 2025 and 2026. Unemployment was stable at 4.0% this year, but was nudged from 4.1% to 4.2% next year and 4.0% to 4.1% in 2026. Members reduced the number of fed funds cuts they saw in 2024 from 3 to 1 but increased next year’s to 4. There was no change to the 2026 rate, still at 3.1%. 

The Fed cited modest further progress toward the 2% inflation objective, an improvement from the May view, and the labor market appears to be relatively balanced. At this point, policymakers seem content to watch and wait. 

The week ended on a flat note, however, as the University of Michigan consumer sentiment survey showed a fall-off in consumer views, especially of current conditions. It also reported a slight increase in longer-term inflation expectations, which bucked the trend seen in other inflation measures. The survey says that this was a statistically insignificant drop from May’s reading, and sentiment is still 31% above the trough seen in June 2022. Even though consumers recognize that inflation has fallen from its highs, and wage gains have been notable, high prices have continued to make budgets tight. Middle-income consumers increasingly share this feeling.

It was a busy week. Markets can take time to digest it all as we slide into summer.