The US CPI in March once again exceeded market expectations, triggering a hawkish cross-asset reaction. Because price pressures remain high, the risk balance is biased towards a later and smaller Fed rate cut than the market had expected. The following is the view of Pepperstone analysts:

Data show that broad-based CPI increased by 3.5% year-on-year in March, a significant increase from 3.2% a month ago, and exceeded market expectations of 3.4% - this is the fourth consecutive broad-based CPI data that is higher than expected. At the same time, core CPI growth was unchanged from last month, with a year-on-year increase of 3.8%.

This is a worrying sign that the progress of disinflation within the US economy may be stalling, which is particularly frustrating for the FOMC, which has been seeking additional "confidence" that inflation is returning to its 2% target. More concerning is that "super core" inflation (core services inflation excluding housing) rose 4.8% year-on-year, the highest level in nearly a year.

However, it is worth noting that the annualized inflation measure is not necessarily the most accurate way to interpret incoming price data, although FOMC members are also increasingly focusing on the 3- and 6-month annualized CPI measures. Of course, PCE inflation, which will be released later this month, remains the main focus.

That being said, these indicators are also worrying. In March, the broad CPI rose 0.4% month-on-month, the same as the previous month, while core prices also rose 0.4%, also the same as the growth rate in February. Obviously, this also shows that the progress of de-inflation is insufficient. Converting these data to annualized data is as follows:

3-month annualized CPI: 4.6%

6-month annualized CPI: 3.2%

3-month annualized core CPI: 4.5%

6-month annualized core CPI: 3.9%

Obviously, this information is easier to see on a chart. This seems to again illustrate the lack of progress the economy seems to be making towards the FOMC's goals, with all of the above indicators rising from the previous month.

Looking more closely at the inflation data, it is clear that the rise in headline inflation was driven primarily by a sharp rise in energy prices, especially gasoline prices, as this component interrupted a disinflationary trend that had lasted for at least 12 months. However, price pressures remain broad-based across all sectors of the economy.

Continuing to focus on the components of inflation, there remains a significant divergence between core goods and core services prices. As commodity de-inflation accelerated, the former fell by 0.6% year-on-year in March, and this component fell back below the average level before the epidemic. On the contrary, service industry prices remain high, rising to 5.4% year-on-year last month, which is likely to be a direct result of the continued tight labor market in the U.S. economy.

While goods disinflation continues, this divergence is of particular concern given the growing upside risks to goods inflation from factors such as persistent geopolitical tensions and rising transport costs. It could lead to a further rise in headline inflation, especially if services disinflation remains very slow, even as prices begin to recover. This is a clear risk, as this report shows.

However, as always, some context is critical to interpreting this inflation report, especially with respect to potential policy implications. While the path back to the FOMC’s 2% inflation target remains tortuous, policymakers are reluctant to overreact to a single data point, especially with two other CPI releases before the June FOMC, and the sell-side consensus still expects the first rate cut to come before then. In addition, it is important to remember that the FOMC actually uses the PCE inflation measure as a guide for policy, not the CPI, and we also have two more PCE reports before the June meeting.

In short, this data may well have been forgotten by the time the June FOMC meeting arrives. Yet, just last week, Chairman Powell noted that it was still “too early” to tell whether recent inflation data were above “noise.” And reports like this, and especially the breakdown of the components, mean that the recent pickup in price pressures may indeed be more than just a blip. As a result, the balance of risks may favor later and fewer rate cuts than previously expected.

This was well evidenced by the clear hawkish response to the data in the USD overnight swap curve. Money markets are now suggesting a June rate cut is only a 20% chance, compared with about 60% before the CPI data was released, while expectations for a July rate cut are only half likely, compared with a certainty before the release. The curve now prices the first full rate cut in September, while only pricing in a total of 50 basis points of rate cuts in 2024, a significant divergence from the median estimate of 75 basis points of easing in March.

Naturally, this change in interest rate expectations triggered a broader hawkish market reaction, with both Treasury and stock markets seeing fierce selling. Both the S&P 500 and Nasdaq futures fell more than 1%, while the policy-sensitive 2-year Treasury yield rose a full 20 basis points from its pre-data level, hurtling toward the 5% mark. Gold also came under selling pressure as nominal interest rates soared. The rise in Treasury yields also pushed up the dollar, including pushing USD/JPY above the 152 mark, which many see as the "bottom line" at which the Japanese Ministry of Finance may intervene.

Overall, the data is a worrying sign for the Fed. It confirms that the hotter-than-expected January and February data, which were previously viewed as noise, may in fact be a sign that price pressures are more persistent and stubborn than expected. The balance of risks clearly points to the Fed remaining a hawkish outlier among G10 central banks as rate cuts in other economies are looming, which could continue to support the dollar. Meanwhile, equities may see corrections remain relatively shallow and short-lived as the policy outlook should remain supportive. Although there is still a chance of rate cuts later this year, the earnings season starting on April 12 will be the key near-term driver. $BTC $ETH $SOL