The markets’ immediate enthusiasm following the April U.S. consumer price index (CPI) report likely reflected relief that inflation did not surprise to the upside, rather than any implied change in the outlook for Federal Reserve policy.

U.S. Treasury yields declined and equity markets rose following the report that core CPI inflation rose 0.3% in April, in line with consensus (and our) expectations, and cooler than the previous month’s data. However, inflation remains well above the Fed’s target, and we would temper any hopes for more or faster policy rate cuts based on this report. That said, in our view the report makes the already remote possibility that the Fed considers hiking rates even less likely.

Fed officials will update their interest rate projections at their next meeting in June, and given recent macro data, we expect the rate path implied by the median “dot” to shift meaningfully higher.

April CPI details positive, but not too encouraging

The slight decline in inflation in April from March was led by lower prices for core goods such as used cars, new cars, and appliances, and a deceleration in the pace of price rises for certain core services like transportation and rent. However, inflation in owners’ equivalent rent (OER) remained strong, and we expect this component will remain relatively stubborn as lease renewals catch up to market rents and single-family rents outperform multi-family.

Overall, we don’t believe the April inflation data were weak or surprising enough to change our medium-term inflation forecasts or our Fed outlook.

The outlook for inflation and policy

The Fed’s long-run inflation target is 2% as measured by core personal consumption expenditures (PCE), and achieving that target seems far out of reach for 2024. We expect Fed officials will revise their inflation projections in June, perhaps shifting the projection of core PCE inflation in 2024 closer to 3%, up from 2.6% projected in March.

Fed officials have stated they do not need to see inflation fully back to target before they’ll begin cutting rates, but even to achieve a more realistic figure of 3% core PCE by December would require inflation to slow to a 0.2% monthly pace for the rest of the year. This compares to 0.32% core PCE inflation in March and our expectations for 0.27% in April. Therefore, to keep annualized PCE inflation sustainably in the “2-point-something” range, we’d need to see a meaningful deceleration from the current pace. Frankly, anything above this makes the optics of a rate cut challenging.

With inflation having fallen dramatically from its peak, the Fed may be comfortable with it hovering above the 2% target for a while. By maintaining its current fed funds rate of 5.25%–5.5%, the Fed may allow the current level of policy restriction to push inflation gradually lower. (Learn more in our recent blog post, “The Fed: Stuck On Hold for Now.”)

Following the rapid increase in the policy rate over the last few years, the U.S. may be poised for a period of elevated and relatively steady rates. Stable growth, low unemployment, and modestly above-target inflation is an economic mix that could keep the Fed from needing to make dramatic moves. This may disappoint investors hoping for a rate cut sooner than later to stimulate growth and boost markets, but we believe the Fed is more likely to take its usual measured approach.

This also means that the Fed could soon become an outlier among developed market central banks: We see prospects for sooner and steeper rate cuts elsewhere, including peer economies such as Canada and Europe. This divergence in policy trajectories – and growth trajectories – will likely be a key theme across the global economy in 2024. For details, please read our latest Cyclical Outlook, “Diverging Markets, Diversified Portfolios.”