The ‘supercore’ inflation measure shows Fed may have a real problem on its hands

A higher-than-expected consumer price index rattled markets Wednesday, but markets are worried about an even more specific price gauge contained in the data – so-called supercore inflation.

Along with the headline measure of inflation, economists also look at the core CPI, which excludes volatility in food and energy prices, to determine the true trend. The supercore gauge, which also excludes housing and rent costs from its service statements, goes even further. Fed officials say the move is useful in the current climate because they view high housing inflation as a temporary problem and a poor indicator of underlying prices.

Supercore accelerated to a 4.8% year-over-year pace in March, the highest in 11 months.

Tom Fitzpatrick, managing director of global market research at RJ O’Brien & Associates, said if you take the last three months’ numbers and annualize them, you get a supercore inflation rate of more than 8%. far from the supercore inflation rate of over 8%. The Federal Reserve’s 2% target.

“As we sit here today, I think they’re probably tearing their hair out,” Fitzpatrick said.

The CPI rose 3.5% year over year last month, above the Dow Jones estimate of 3.4%. The data pressured stocks and pushed Treasury yields higher on Wednesday, and caused futures market traders to extend their expectations for the central bank’s first rate cut into September from June, according to the CME group’s FedWatch tool.

“At the end of the day, they don’t really care as long as they get to 2%, but the reality is you’re not going to get to a sustained 2% rate if you don’t get a key cooling in prices services., (and) at this point we don’t see it,” said Stephen Stanley, chief economist at Santander US.

Wall Street has been well aware of the trend coming from supercore inflation since the start of the year. A rise in the indicator from January’s CPI was enough to hamper the market’s “perception that the Fed was winning the battle against inflation (and) this will remain an open question for months to come,” according to the head of US rates at BMO Capital Markets. strategy Ian Lyngen.

Another problem for the Fed, Fitzpatrick says, is the different macroeconomic backdrop of demand-pull inflation and strong stimulus payments that have allowed consumers to increase their discretionary spending in 2021 and 2022 while fueling levels record inflation.

Today, he added, the situation is more complicated because some of the most stubborn components of service inflation are basic necessities like auto and home insurance as well as property taxes. .

“They are so scared by what has happened in 2021 and 2022 that we are not starting from the same point as on other occasions,” Fitzpatrick added. “The problem is if you look at it all (together), it’s not discretionary spending (and) that puts it between a rock and a hard place.”

The situation is further complicated by falling consumer savings rates and rising borrowing costs, which make the central bank more likely to maintain a tight monetary policy “until something breaks,” he said. Fitzpatrick said.

The Fed will struggle to bring down inflation with further rate hikes because current drivers are more challenging and less sensitive to tightening monetary policy, he warned. Fitzpatrick said recent increases in inflation are more closely analogous to tax increases.

Although Stanley believes the Fed is still a long way from raising interest rates further, it will remain a possibility as long as inflation remains high above its 2% target.

“I think overall inflation will come down and they will cut rates later than expected,” Stanley said. “The question is, are we dealing with something that has become entrenched here? At some point, I imagine the possibility of rate hikes will come back to the forefront.”