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Inflation is slowly moving lower, with ‘slowly’ being the operative word. Both consumer and producer prices cooled just enough in April to suggest inflation is continuing on a downward path but at a more moderate pace than last year. Headline and core CPI rose 0.4% for the month, as expected, while the same measures for PPI fell to 0.3% and 0.2% respectively. Year-over-year CPI fell to 4.9%, the first time below 5% in two years and well below the 9.1% peak rate reached in June 2022. Housing and services inflation continue to remain stubbornly high despite smaller monthly increases. Shelter costs rose 0.4% in April, the smallest rise in a year, and rental price increases were below the 12-month average. Declines in airfares and hotels kept a lid on core services. Core goods prices increased the most in almost a year, mainly due to a 4.4% spike in used car prices. New car prices, on the other hand, unexpectedly fell, as did appliances.
The slowing of price increases, especially at the wholesale level, gives the Federal Reserve an opportunity to pause its aggressive rate hiking strategy. While the financial markets continue to bet on rate cuts this year, the slowing pace of inflation is not enough for the Fed to change tactics. At best, the Fed will keep the fed funds rate at the current range in June and monitor price changes from there.
Key Indicators this Week
Consumer Sentiment – After months of improvement, consumer sentiment reversed course this month and fell substantially on renewed inflation concerns. According to the University of Michigan Sentiment survey, consumers see inflation remaining elevated over the next five to 10 years and staying close to 4.5% for the next 12 months. Despite data pointing to a strong labor market and good consumer spending, even with interest rates at decades high levels, consumers are becoming increasingly worried due to the barrage of negative news, expectations for a recession and the unsettled debt limit crisis. Buying conditions for durable goods declined to a five-month low in early May, with about 42% of respondents blaming high prices for eroding their living standards. While consumers judge their current financial situation as slightly improved, the expectations for the future deteriorated.
ISM – The ISM index of factory activity increased more than expected in April, suggesting continued improvements in the manufacturing sector, albeit at a slow pace. The gain was driven by a jump in new orders, better delivery times and a decline in the backlog of orders. Supply chain issues are improving but the industry remains in contraction rather than expansion territory. The prices paid sub-index increased four points to 53.2, the highest level since July 2022. The move into expansion (above 50) will keep the Fed on track to maintain higher than normal interest rates.
Lending – The Senior Loan Officer Opinion Survey revealed tighter standards, wider spreads and increased collateral requirements for commercial and industrial loans in the first quarter. At the same time, the demand for credit fell 56% in the same time period, the sharpest drop since the financial crisis in 2009. Most banks surveyed reported tightening standards “somewhat” rather than “considerably,” suggesting the change is related to a lack of deposits and demand rather than falling credit quality. The survey includes up to 80 large domestic banks and 24 U.S. branches and agencies of foreign banks. Credit unions are not included.
Sarina Freedland – Senior Investment Officer
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