📉 Inflation Shows Signs of Cooling, Fueling Rate Cut Expectations — But Risks Remain

On April 30, the U.S. Commerce Department released March data for the Core Personal Consumption Expenditures (PCE) Price Index—a key inflation metric closely watched by the Federal Reserve. The report showed core PCE rose 2.6% year-over-year, easing from February’s revised 3% and marking the lowest reading since June 2023. On a monthly basis, core prices were flat (0%), falling short of the anticipated 0.1% increase. This adds to growing evidence that inflationary pressures are gradually easing, fueling market speculation that the Fed could begin cutting interest rates as early as June.

Digging into the details, goods prices fell by 0.5% in March, reversing a small increase in February. This decline is likely due to improving supply chains, especially for durable goods, and efforts by businesses to offload inventory ahead of potential new tariffs. While service prices continued rising, the gain slowed to just 0.2%, down from 0.5% the month prior—mostly driven by easing costs in housing and healthcare. Energy prices dropped sharply by 2.7% amid shifting global oil dynamics, though food prices climbed by 0.5%, impacted by extreme weather.

Despite easing inflation, real personal spending rose a robust 0.7%—the largest increase since late last year. This suggests U.S. households, even in the face of elevated interest rates on mortgages, auto loans, and credit cards, are drawing on savings to keep spending afloat. The personal savings rate fell to 3.6% in March, signaling shrinking financial buffers. The combination of cooling inflation and resilient consumption gives the Fed increased flexibility as it weighs its next moves.

Markets reacted swiftly to the report. According to CME data, the probability of a June rate cut jumped from 58% to 76%, with traders now pricing in as many as four cuts in 2024. Two developments are driving optimism: First, core PCE has now declined steadily for four straight months from its recent peak of 2.8%. Second, personal incomes rose by 0.5% in March—above the expected 0.4%—indicating stable wage growth without overheating inflation, lowering the risk of a wage-price spiral.

Former Fed Vice Chair Richard Clarida noted that while the job market remains resilient, the case for a “preemptive rate cut” strengthens if inflation continues to ease. He also referenced the Fed’s March meeting, where policymakers warned that delaying action too long could raise the risk of a hard economic landing—perhaps explaining the sharp uptick in market expectations for a rate cut.

Following the inflation update, the U.S. dollar index edged up 0.35% to 99.52, reflecting mixed interpretations—declining inflation on one hand, but strong wage and consumer data on the other. Yields on 2-year Treasuries fell 6 basis points to 4.12%, pointing to rate cut expectations, while the 10-year yield rose to 4.38%, suggesting confidence in longer-term growth. In equities, the S&P 500 was largely steady, though tech stocks led gains thanks to easing rate pressures. Meanwhile, gold prices surged past $2,350/oz to a record high, as investors seek safety amid policy uncertainty.

Historically, today’s inflation moderation differs from past disinflation cycles. Post-pandemic easing stemmed largely from collapsing demand, whereas today’s trend owes more to supply chain normalization and delayed policy effects. Compared to the mid-1990s soft landing—when the Fed cut rates preemptively in July 1995 after core PCE hit 2.6%—today’s labor market is tighter, requiring more precision from the Fed.

Looking ahead, the Fed still faces risks despite the improving inflation picture. Geopolitical tensions could drive oil prices higher, reintroducing energy cost pressure. And with the 2025 presidential election approaching, any sudden fiscal policy changes—like tax cuts or new government spending—could re-ignite demand-side inflation.

There’s also uncertainty around the impact of pending tariffs on imports from China. According to analysis from the Atlanta Fed, these new trade barriers may not show up in inflation data immediately, but could complicate inflation forecasts and policy decisions in the months ahead.

Bottom line: March’s PCE data offers reassurance that inflation is cooling without derailing consumer momentum. This gives the Fed breathing room to consider rate cuts as early as this summer. Still, with global risks looming, policymakers will need to tread carefully to ensure the recovery stays on track.