News & Analysis

Following concerning soft survey data at the beginning of last week, markets have been fretting over the idea that the US economy was hurtling towards a recession even before the effects of the regional banking crisis on credit conditions could be felt in the real economy.

In a similar fashion to last week’s payrolls data for March, today’s release of March’s CPI report has helped to partially dispel such fears and has largely consolidated a further, and potentially final, 25bp hike from the Federal Reserve in May should policymakers see no signs for concern within their richer dataset on overall credit conditions. Meeting expectations, headline inflation fell from 6% to 5% YoY, largely due to deflation in energy commodities, while the core measure ticked up 0.1pp to 5.6% YoY due to the still-elevated pace of sequential core inflation growth at 0.4% MoM. For markets, it is the latter figure that is most pertinent out of the headline data as it shows that underlying demand within the US economy remains significant enough to sustain inflation above the Fed’s 2% target.

For reference, once measured over a 3-month average to smooth out monthly volatility and then annualised to facilitate comparison, the pace of core inflation is more than double that of the Fed’s target for the headline measure at 5.1% YoY.

Stripping out further influences such as core goods and shelter inflation to get a cleaner read on domestically-driven price pressures, the Fed’s favoured supercore measure of inflation remains uncomfortably high at 5.8% YoY, although some progress has been made from the 6.1% reading the month prior. Not only does this reinforce the need for a further rate hike from the Fed as per their March guidance, but it doesn’t necessarily represent an outlook for domestic demand that is about to capitulate under imminently tightening credit standards and a collapse in consumer sentiment. This is also visible at the component level where price pressures in discretionary services, such as restaurants (+0.6%) and flights (+4.0%), are still showing strength.

The annualised rate of the three-month average core CPI figure remains significantly above the Fed’s 2% target and should keep expectations firm for a further 25bps hike next month 

On a component level, the main downward contributor to inflation in March came from falling energy costs (-3.5%), with both energy commodities (-4.6%) and services (-2.3%) falling further into negative territory.

Food price inflation fell to 0% as the contribution from groceries (-0.3%) turned negative, offsetting still strong price pressures at restaurants (+0.6%). Core inflation was essentially unchanged at 0.4%, with services still driving the lion’s share of continued upward pressure. Core services—which strip out utilities—did edge down by 0.1pp, but at 0.4% they still suggest that headline inflation is not about to return to 2% anytime in the next few months.

While broader aggregates within the services basket, such as shelter, medical care, and transportation, did not meaningfully change from February, several developments at a more granular level are worth noting.

For one, medical care was the only service to see prices fall outright, with hospital services falling by -0.4% after printing flat last month. Additionally, air fares continued to rise 4% MoM, down from February’s reading of 6.4% but not showing any significant disinflation as suggested by cheaper jet fuel costs. Finally, while shelter remains by and large the main source of services inflation, shelter inflation trimmed back to 0.6% on softer rent (+0.5%) and OER inflation (+0.5%).

But continued progress in the Fed’s favoured “supercore” measure of inflation suggests rate hikes beyond May are unlikely, especially once factoring in tighter credit standards

As mentioned, both aggregate data for core services and data on a more micro level showed that the US economy is still experiencing enough domestic demand to sustain inflation above target.

For markets, the most important takeaway is that this doesn’t necessarily confirm a sudden nosedive in the US economic outlook either before or immediately after the regional banking crisis in mid-March, and with the Fed’s supercore measure of inflation cooling slightly from 6.1% in February to 5.8% YoY, it doesn’t suggest that inflation is so persistent that it requires interest rates near the market-implied terminal level seen prior to the collapse of Silicon Valley Bank.

In this regard, and in a similar fashion to Friday’s payrolls report which showed the US economy continued to add a significant number of jobs but without the inflationary by-products it once did, today’s inflation report can be seen as a goldilocks release for markets.

Inflation concerns are partially retrenching, with the 2-year inflation breakeven falling 19bps below 2.5%, alongside recession concerns as US equity futures continue to trade in the green pre-market. In FX markets, the goldilocks report has weighed on the dollar in an indiscriminate manner. Not only are high beta currencies posting significant gains against the greenback, but so are rate sensitive currencies such as JPY as the US 2-year falls below 4% as the risk of a more substantial upside surprise in today’s inflation figures is discounted.



Simon Harvey, Head of FX Analysis
Jay Zhao-Murray, FX Market Analyst
Nick Rees, FX Market Analyst


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