FOMC sends mixed signals

The May Consumer Price Index (CPI) gave the Federal Reserve some wiggle room, as the annual price change fell from 4.9% to 4%, the smallest 12-month increase since March 2021. Key drivers were falling energy prices, down 11.7%, partly offset by higher food prices, up 6.7% in the last year. Excluding these more volatile components, the annualized CPI increase fell from 5.5% to 5.3%, an improvement for sure, but still well above the Fed’s preferred 2% level. Shelter costs, food prices and used vehicle prices contributed to the increase and remain volatile. Trends in underlying core inflation show a very slow march lower. Is that enough for the Fed?

Yes and no. The Fed did not hike at this meeting, but Chair Powell said several times that the next meeting could see a rate hike. His view is that inflation is moving in the right direction, but just not fast enough. The Fed did update its quarterly economic projections, which showed higher growth and lower unemployment, but a higher fed funds by year-end 2023. Markets initially struggled with how to interpret the Fed message: if inflation is still too high and won’t get back to the Fed’s 2% target until year-end 2025, why is the Fed forecasting rate cuts in 2024 and 2025? Powell indicated that the Fed wanted to see how incoming economic data looked before committing to a path.

Throwing another curveball was the semi-monthly University of Michigan Sentiment index, which strengthened to its highest level since February. Consumers took heart in falling gasoline prices and the resolution of the debt ceiling crisis. Importantly, year-ahead inflation expectations fell from 4.2% to 3.3%, and longer-term expectations fell from 3.1% to 3%, in the range where they have spent most of the last two years. Nearly three-fourths of consumers still view inflation, not unemployment, as the greater challenge for the economy. Financial conditions appear to be easing, probably not what the Fed wants at this stage. The Fed’s job just doesn’t get any easier.