Could the latest U.S. inflation report alter the Fed’s rate-hiking plans?

Executive summary:

Consumer price increases eased in the U.S. during March
The Fed appears likely to raise interest rates again in May
Analysts expect U.S. Q1 earnings to decline by 6.8%

On the latest edition of Market Week in Review, Chief Investment Strategist Erik Ristuben and ESG and Active Ownership Analyst Zoe Warganz discussed the U.S. CPI (consumer price index) report from March and whether the latest numbers could impact the chances of a U.S. Federal Reserve (Fed) rate hike in May. They also previewed what to expect during first-quarter earnings season in the U.S.

U.S. headline inflation cools, but prices for services remain high

Warganz and Ristuben kicked off the conversation with a look at the latest U.S. CPI data from March, which was released 12 April by the Labor Department. The report showed that core inflation – which strips out prices from the volatile food and energy sectors – is more problematic than headline inflation, Ristuben said, noting that headline inflation was up just 0.1% on a month-over-month basis. Core inflation, on the other hand, rose 0.4% from February, he said.

Ristuben added that on an annual basis, headline inflation climbed by 5% – the slowest increase since June 2021 – while core inflation rose at a 5.6% clip. Both numbers remain well above the U.S. Federal Reserve (Fed)’s target of 2%, he noted.

"One of the key takeaways from this report is that goods – in other words, things – aren’t the source of inflation anymore. Price pressures today are mainly being seen in stickier categories, such as services and shelter," Ristuben remarked. He said that he anticipates shelter inflation to ease in the coming months, but that inflation in the services sector remains more of a problem. This is due to ongoing wage pressures in the U.S. economy, Ristuben explained, noting that the Atlanta Fed’s wage growth tracker showed that median wages climbed 6.4% in the first three months of the year.

In addition, the services sector has seen strong growth in recent months, he said, noting that the leisure and hospitality sector gained 72,000 jobs in March. "There’s probably a good reason to expect that a lot of recent hiring in this sector is catch-up hiring – in other words, the hiring is coming from businesses that weren’t able to attract as many employees the past few years because all the big firms were on rampant hiring sprees", Ristuben stated. He said he expects services-sector hiring to gradually begin waning, but added that until that happens, inflation may not move downward much more.

Another Fed rate hike in May appears likely

Next, Warganz asked Ristuben if the latest data on U.S. inflation and jobs could have any impact on potential Fed rate hikes. "I don’t see anything in the latest numbers to change my expectation that the Fed will lift borrowing costs again at its next meeting – likely by 25 basis points (bps)," Ristuben replied. He noted that minutes from the Fed’s 21-22 March policy meeting – which concluded with a 25 bps rate increase – also showed that the central bank remains strongly committed to taming inflation.

During the meeting, a presentation from Fed staff members was shared with FOMC (Federal Open Market Committee) officials, Ristuben explained. "The staff projected that a U.S. recession will likely begin later this year, due to the mid-March banking crisis," he said. Critically, despite this forecast, Fed members still voted to lift rates, he noted.

This cements the view that Ristuben has hammered home for much of the past 12 months – that the U.S. central bank views inflation, not a recession, as public enemy number one. "Fed officially have said continuously that persistently high inflation is the greater threat to the U.S. economy – and because of this, they’re willing to subject the economy to a recession if that will help bring inflation under control," he stated.

Dismal outlook for Q1 earnings season

Warganz and Ristuben wrapped up the segment with a discussion on what to expect during first-quarter U.S. earnings season, which kicks off in mid-April. Ristuben said that analysts are expecting earnings for S&P 500 companies to decline by 6.8% when compared to the first quarter of 2022.

Interestingly enough, at the end of December, analysts were projecting just a -0.3% decline in first-quarter earnings growth, Ristuben said. "As the first quarter of 2023 progressed, however, earnings expectations turned lower and lower – to the point where some analysts are now bracing for an earnings recession," he remarked.

This sets the stage for what Ristuben expects to be a very interesting earnings season, with investors likely to pay careful attention to whether or not corporate earnings pan out as badly as expected. The results of first-quarter earnings season could provide some clues into the potential path ahead for the stock market in the next few months, he noted.

"At the end of the day, I think corporate earnings are going to be a pretty big issue for investors this year," Ristuben stated, noting that the earnings season will be in full swing the week of 17 April.

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Any opinion expressed is that of Russell Investments, is not a statement of fact, is subject to change and does not constitute investment advice.