May report will show how much the Iran conflict has boosted inflation
The Federal Reserve’s main indicator for inflation showed some good news on Thursday, but it came with a major caveat.
Core personal consumption expenditures (PCE), the central bank’s favored inflation indicator, increased 3.0% in February. This was 0.1% less than the increase in January.
Overall, PCE rose 2.8% in February, which includes both food and energy prices. However, the data does not reflect the surge in oil prices that occurred in March and April due to the conflict in Iran. Those impacts will start to show up in the May report.
It is unlikely that the Federal Reserve will cut rates at its April 29 rate decision. CME FedWatch puts the odds of a rate hold at 98.4% as of Thursday morning. It doesn’t predict a rate cut until September 2027.
Hope that the ceasefire holds
The markets are hoping that the tenuous ceasefire currently in place in the Iran conflict will start to bring energy costs in check.
Brent crude oil, which was trading near $60 a barrel in January, spiked to $119.50 a barrel after the war intensified and the Strait of Hormuz was closed.
On Wednesday, after the ceasefire, the price of oil dropped to near $90 a barrel as there was hope that the Strait of Hormuz would reopen and the flow of oil would resume. However, Iran has threatened to close it again as it feels the recent Israeli attacks on Lebanon violate the ceasefire. In response, oil prices have moved back up closer to $100 a barrel on Thursday morning.
Oil is one of the biggest drivers of inflation, and if oil prices remain elevated, the inflation numbers that come out in May and June will likely reflect that, and could impact the path of the Fed going forward.
Fed chair Jerome Powell said in his post-meeting press conference that the unknown with the conflict makes it hard to know how drastic the impacts are going to be.
“I want to emphasize, nobody knows,” Powell said. “The economic effects could be smaller or much bigger. We just don't know. If we have a long period of much higher gas prices, that is going to weigh on consumption and disposable personal income and consumption. We don't know if it will happen. I wouldn't say there is a conviction that this is going through quickly or not quickly.
“The implications of the events in the Middle East for the US economy are uncertain. In the near term, higher energy prices will push up overall inflation. It is too soon to know the scope and duration of the potential effects on the economy.”
Rate hikes unlikely, but not ruled out
The path ahead for the Federal Reserve will likely be a tricky one, especially if inflation sees a sharp increase. Many believe the job market isn’t very stable either, with large tech layoffs in recent months.
Fed member Beth Hammack told the Associated Press that she saw a possibility that rates could be moved in either direction, depending on which side of the mandate worsened more.
"I can foresee scenarios where we would need to reduce rates … if the labor market deteriorates significantly," Hammack said. "Or I could see where we might need to raise rates if inflation stays persistently above our target."
In the Fed meeting minutes released on Wednesday, several members mentioned the possibility that rate increases might be necessary.
"Some participants highlighted the possibility that after several years of above-target inflation, longer-term inflation expectations could become more sensitive to energy price increases,” the minutes noted. “Participants noted that progress toward the Committee's 2% objective could be slower than previously expected and judged that the risk of inflation running persistently above the Committee's objective had increased."
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