Fed wants to cut rates, but inflation won't cooperate

After hitting year-to-date highs in late April, Treasury yields have fallen so far in May, with the benchmark 10-year Treasury yield down about 0.20%. Modestly better inflation data and market understanding that the Federal Reserve wants to cut short-term rates have been the key drivers. Recent speeches from Fed members have made clear they will be patient, however, and the minutes from the last Fed meeting indicate that policymakers are disappointed in the slow progress on reducing inflation. The desire to cut is there, but the Fed wants to see confirming evidence that inflation is slowing. 

Data continues to point to a steadily growing economy with a still-tight labor market. Weekly jobless claims fell from 223,000 to 215,000, indicating that layoffs remain low, and a report from S&P Global showed that both manufacturing and services activity rose more than expected in May. The report said business activity rose to its fastest pace in over two years, employment fell marginally and input prices continued to rise, though the inflation rate  across both goods and services remained below the average recorded over the past year. April durable goods orders rose more than expected, but March’s orders were revised lower. The takeaway here is that the manufacturing sector appears to be stabilizing, with moderate gains. 

Though consumer sentiment as measured by the University of Michigan survey fell in May, it rebounded in the second half of the month. Consumer views of current and expected conditions both increased, while their 1-year ahead and 5-10 year inflation expectations fell back. While better, these inflation readings are still above pre-pandemic levels. Long-run expectations at 3.0% have been in a 2.9-3.1% range for nearly three years, but that is still above the 2.2-2.6% range before the pandemic. The bottom line is that progress is being made, however slowly. The relatively easy gains have been made, and now the last bit is grinding forward.