News & Analysis

With base effects always expected to weigh on the year-on-year inflation print, the focus for markets today was on the month-on-month reading, and more specifically, core CPI MoM.

With expectations sitting in a range of 0.3-0.5% MoM for the core measure, the final print of 0.6% blew economist estimates out of the water. For context, twelve consecutive 0.6% monthly prints would annualise to a 7.4% gain, well above the Fed’s 2% inflation target. In year-on-year terms, the core measure also outstripped expectations by 0.2 percentage points at 6.2%, down from 6.5% last month. Headline data, which is being largely discounted by market participants due to the energy market impacts, fell to 0.3% MoM and 8.3% YoY.

While today’s report highlights that the peak in US inflation is behind us in March, today’s core reading shows the first signs that strong domestic demand conditions could offset upcoming disinflationary base effects.

If the same trend in April is continued, this will lead to a slower natural disinflationary channel throughout the year, thus putting the onus back on the Fed to quell inflation pressures arising from domestic demand. Within the CPI report, core services inflation, which is the sub-index of the CPI basket most sensitive to tighter financial conditions, confirms the view that more front-loaded tightening by the Fed is required after printing at 0.72% MoM—a fresh post-1990 high.

In response to the report, US Treasury yields climbed higher as rates traders priced a more hawkish Fed. The move higher in the Treasury curve was driven by the front-end rates, which catapulted the US dollar out of the doldrums to post gains on the day against most of the G10 currency board. AUD felt the most pain within the G10 FX space, dropping over a full percentage point against the dollar. Thankfully for USD bears, however, the move higher in the greenback was partially reversed as time elapsed and Treasury markets stabilised. The fact that a 50 basis point hike at June’s meeting was already set in stone likely contributed to this as near-term Fed pricing is largely capped to the upside.

Energy price decline drives headline inflation decrease, but core goods and services signal growing domestic demand-pull pressures will keep fuelling inflation

The details of the April CPI report confirm the hot inflation conditions as outlined by the MoM core reading. Core services inflation rose by 0.72% MoM, contributing 85% of the increase in the 0.6% core reading, while the 0.2% MoM increase in core goods had a much more muted impact.

Within the core services index specifically, shelter and transportation services provided the biggest upward contribution to the overall core reading, at 0.21% and 0.22% respectively. However, the impact of transportation services is being overrepresented, largely due to the fact that 0.17% of the 0.22% contribution was derived from rising airline fares (+18.6% MoM). This will likely drop off in the coming months, owing to the stabilisation in fuel costs and demand. For core goods, the expected decline in used car prices did continue the trend from February and March, although the 0.4% monthly fall contributed a negligible -0.02% to the overall core reading. That dip was also outweighed by a 1.1% MoM increase in new cars, leading to a 0.06% contribution to core inflation.

Regarding the deceleration in headline inflation, the main driver wasn’t just energy in general which fell by 2.7%, but gasoline specifically (-6.1% MoM). The contribution from gasoline was -0.28% on the headline monthly print, which provides some relief to consumers who have been strained by prices at the pump since Russia’s invasion of Ukraine caused a spike in crude oil prices.

On net, while we continue to expect sequential growth in core inflation to moderate in the coming months, today’s stronger-than-expected print throws a spanner in the works for our contrarian forecast of a 25bp hike at July’s meeting.

While one data point isn’t a trend, the probability of the Fed reverting back to 25bp hiking increments in July has substantially moderated on the back of today’s inflation data. However, with two more CPI reports due to be published prior to July’s meeting, a 25bp hike in July isn’t a remote possibility just yet.




Simon Harvey, Head of FX Analysis

Jay Zhao-Murray, FX Market Analyst


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