Hotter-than-expected CPI report shows broader-based inflation that will be 'very hard to kill'

Published Wed, May 11 202211:15 AM EDTUpdated Wed, May 11 20224:30 PM EDT

Patti Domm @in/patti-domm-9224884/@pattidomm

Consumer inflation accelerated at a hotter-than-expected 8.3% pace in April, fueled by a broader swath of price gains across the services sector — a sign that inflationary pressure may not abate anytime soon. The consumer price index did moderate, as expected, from March's 8.5% level, but it increased more than the 8.1% forecast by economists surveyed by Dow Jones. Core inflation, which strips out energy and food prices, climbed 6.2%, more than the 6% that was expected. Markets were braced for a positive report , anticipating confirmation that inflation peaked in March, and that was expected to give a lift to risk assets. Stock futures initially pulled back, and Treasury yields rose after the 8:30 a.m. ET release. Stocks then reversed course and were higher in morning trading, but fell sharply again later in the day. The S & P 500 ended the day at 3,935, off 1.6%. "Even though the data was higher than expected, it was lower than March so it did add a little to the peak inflation narrative being behind us, and the Fed is showing us they are willing to act," said Ben Jeffery, BMO fixed income strategist. That sentiment helped lift stocks early in the day, but traders were focused on the potential for an economic downturn later in the session. The markets have been battered for weeks by worries that rising inflation could bring on aggressive Federal Reserve rate hikes and lead to a recession. Treasury yields, which move opposite to price, were mostly higher in morning trading, and the 10-year yield edged back above the key 3% level but it was at 2.93% by late afternoon. In the fed funds futures market, BMO's Jeffery said the contracts showed traders soon after the CPI reprot were expecting the fed funds rate to go up by 2 percentage points by year-end. He said the market was priced for a half-point hike in June, another in July and between a quarter-point and half-point hike for September. "That will be the next debate, whether September is 25 or 50 basis points. It's now pricing a split," he said. A basis point equals 0.01 of a percentage point. The Fed raised its fed funds rate by a half-percent this month, after a quarter-point hike in March. On a monthly basis, April's 0.3% gain in headline inflation was higher than the 0.2% expected, but well below the 1.2% pace in March. Core inflation rose 0.6% in April, a more rapid increase than the 0.3% in March. Inflation will be 'very hard to kill' A culprit was services sector inflation, which rose at a 0.7% rate in April. It has been ticking up, rising 0.6% in March and 0.5% in February. Last month, there were declines in goods such as apparel, electronics and used cars. Apparel declined 0.8%, while used cars were down 0.4%, still up 22.7% in the past 12 months. "Despite the fact there was easing in the goods sector, it's still very hot on the whole because services are accelerating," said Jefferies chief financial economist Aneta Markowska. "Inflation's very sticky and driven by the labor market, and it's going to be very hard to kill that. I think it's going to sort of light a fire under the Fed, if they didn't feel a fire already." Energy was down 2.7% in April after an 11% gain in March. That was driven by a temporary drop in gasoline prices but offset by gains in natural gas prices and electricity, according to the Bureau of Labor Statistics. Airfares jumped 18.6% in April — the largest gain since the data series began in 1963. Shelter increased a half-percent, the same as March. "I think it was pretty ugly. There's just no silver linings in here," said Markowska. "You could make the case that some of these are one-offs and they won't be sustained. You could strip out airfares, and core is still up 0.5%. Housing inflation is still very hot. You're seeing it across the board in the service sector, whether it's medical care, education, recreation, and I think those are very much driven by labor costs. And that's not going to subside any time soon." While energy moderated, food was still rising in April. The index for food at home was up 1%, after rising 1.5% in March. The index for dairy and related products was up 2.5%, its largest monthly increase since July 2007. Michael Schumacher, direct rates strategy at Wells Fargo, said the CPI report was bearish, and the market focus is now on the next batch of inflation readings. The producer price index is released Thursday morning. "Really, the takeaway is it's broad-based inflation, and that's what the Fed doesn't want. It's more evidence the Fed is behind the curve," he said. He noted that Fed Chair Jerome Powell said after the Fed's May meeting that the central bank was not currently expecting a 75 basis point hike. "If you get a couple more reports like this, what does the Fed do in September or November? Does it think about 75 basis points? Sure, that could happen," he said. Schumacher said the futures market has edged slightly higher, but it's not pricing in any 75 basis-point hikes. But the market is now expecting about an 65% chance of a half-point hike in September.

Shoppers inside a grocery store in San Francisco, California, U.S., on Monday, May 2, 2022.

David Paul Morris | Bloomberg | Getty Images