May's tame consumer price index data was a big enough surprise to change the focus for today's Federal Reserve meeting. Concern over an unexpectedly hawkish shift in the rate-cut outlook has melted away. Now the question is whether Chair Jerome Powell will try to rein in Wall Street's celebratory mood that's pushing the S&P 500 to a new intraday record.
The core CPI rose just 0.16% on the month, about half of the 0.3% forecast and the tamest core inflation reading since August 2021. Meanwhile, core service prices rose just 0.2%, after six straight readings of 0.4% or higher.
Fed Rate-Cut Odds
After the CPI inflation data, markets are pricing in 71% odds of a rate cut by the Sept. 18 Fed meeting, up from 54% ahead of the CPI. Markets now see 72% odds of two quarter-point rate cuts before the end of this year, up from 51%.
Fed Projections
Ahead of the CPI surprise, the suspense around today's Fed meeting centered on the quarterly rate-cut projections that will be released at 2 p.m. ET. The new projections are expected to pencil in 50 basis points in rate cuts this year, keeping a September rate cut in play. However, before the tame CPI, Wall Street saw an outside chance that the Fed might signal just one quarter-point move, delivering a gut punch to the S&P 500.
There is still a bit of suspense over what the Fed projections will show. Assuming the Fed pencils in two rate cuts for 2024 — one fewer than in March — the question is whether they'll also raise the projected year-end rate for 2025 by a quarter point. That would keep the Fed funds rate north of 4% for the next year and a half. As of March, projections showed the Fed's key rate falling to a range of 3.75% to 4% next year.
Either way, the Fed rate-cut outlook — which reflects the median of individual projections made by each policymaker — is likely to show a very divided Federal Open Market Committee, or FOMC.
The last batch of projections in March indicated that 10 committee members were forecasting three quarter-point cuts, while nine members saw two rate cuts or fewer. At the time, Chair Powell's comments made clear that he was holding the narrow majority together.
What Will Powell Say?
It's a good bet that Powell will be somewhat more circumspect about the inflation outlook. For one thing, the CPI has a lot of differences from the Fed's primary inflation rate, the core PCE price index.
We'll have a much better idea after Thursday's producer price index release whether core PCE inflation will be similarly tame in May. Some PPI data feed directly into PCE inflation, including health care services, which is the biggest component of the core PCE price index.
Fed policy isn't generally moved by a single month of data. Policymakers have said it will take a number of months to gain the confidence that inflation is on a path back to the 2% target, though the May CPI data is a great start.
Financial Conditions
The big picture is that the Fed policy rate of 5.25% to 5.5% is, as Chair Powell has said, "well into restrictive territory." In other words, interest rates are clearly high enough to be exerting downward pressure on economic growth and inflation.
Still, the economy has been holding up pretty well, as the solid jobs gain in Friday's employment report suggests.
One view on Wall Street is that Fed interest-rate policy hasn't worked as expected because financial conditions are too easy.
Indexes of financial conditions compiled by Goldman Sachs and the Chicago Fed that factor in stock prices, borrowing costs, demand for credit and the dollar's exchange rate show that conditions are no tighter than they were before rate hikes began in March 2022. The AI-led S&P 500 rally is the biggest reason why financial conditions have defied high rates.
Wednesday's rally in stock and bond markets, along with a drop in the dollar, just made financial conditions even easier. The Fed doesn't target stock prices directly, but persistent changes in financial conditions can affect policy.
At some point, Powell may express some unease about financial conditions if the S&P 500 keeps rallying, but so far there's no sign he's ready to go there.
S&P 500
The S&P 500 rose 1.1% in Wednesday afternoon stock market action. That followed Tuesday's 0.3% gain that lifted the S&P 500 to its 27th record closing high this year.
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