Hot US economy dampens hope for rate cuts

Economic data across multiple metrics is coming in hot, showing the strength of the U.S. economy and the persistence of inflation in the last mile of its descent down to the Federal Reserve’s target rate of 2 percent.

A March uptick in the consumer price index (CPI) to an annual 3.5-percent increase could push interest rate cuts back from their predicted start date in June. The CME FedWatch forecasting algorithm put the probability of a June cut at just 21 percent Wednesday morning.

The algorithm has higher odds for a cut than a pause at the rate’s current range of 5.25 to 5.5 percent starting in September.

“The lack of downward momentum in core inflation will be met with some discomfort within the [Fed], especially as some Fed officials are growing increasingly uneasy about cutting rates amid inflation stickiness,” wrote EY senior economist Lydia Boussour and chief economist Gregory Daco in a Wednesday analysis.

“Still, many will wait to observe the read on their favored inflation gauge — PCE inflation — later this month before adjusting their views,” they wrote, referring to the Commerce Department’s personal consumption expenditures (PCE) price index, the Fed’s preferred gauge of inflation.

‘Core’ inflation goes up for the first time in a year

The CPI rose by 0.4 percent in March to hit a 3.5-percent annual increase, topping analysts’ expectations. It’s the third month in a row of 0.4-percent monthly growth.

With the less predictable categories of food and energy prices removed, the CPI rose for the first time in a year, ticking up to 3.79 percent from 3.76 percent in February.

Inflation has been coming down since the middle of 2022, falling from a 9-percent annual increase down to 3.2 percent in February.

However, the final percentage point in the path to 2-percent annual inflation is proving the trickiest, as the CPI has bounced between 3 percent and 4 percent for nearly a year. 

The March bump to 3.5 percent is still not the highest it’s been during that period, with CPI having hit 3.7 percent last August.

Profits are at record highs, and production is booming

After-tax profits hit a record high of $2.8 trillion in the fourth quarter of 2023, beating the previous high of $2.7 trillion in the third quarter of 2022, according to federal data.

Profits jumped 3.9 percent that quarter, blasting through economists’ expectations of a 3.3-percent increase.

Profits as a share of prices grew throughout 2023, advancing from 15.9 percent of the price per unit of added value in the economy to 17.1 percent. Meanwhile, employee compensation during 2023 fell from 57.7 percent of prices to 57.3 percent, with the remainder of the difference made up by falling input prices, bolstering arguments about profit-led inflation.

Gross domestic product (GDP) has also surged on the back of stimulus funds pumped into the economy following the pandemic, with total output in the 2020s adjusting to a new steeper trend line than in the decade before.

GDP rose at an annualized rate of 3.4 percent in the fourth quarter after surging by 4.9 percent in the third quarter. As of April 4, the Atlanta Fed projected 2.5-percent annualized quarterly growth for the first quarter of 2024, though projections have been above 3 percent for much of the year.

Job market is still hot, though less advantageous to workers

Job creation in March came in well above expectations, with 303,000 new payrolls added to the economy.

March job gains were driven by a limited number of sectors including health care, government and the typically lower-paid leisure and hospitality industry.

The job market crushed expectations throughout 2023 as immigrants helped to boost the labor force and alleviate what business groups frequently termed a “labor shortage.”

While hiring is still robust and unemployment remains below 4 percent of the workforce, the rate at which people have been quitting their jobs — widely viewed as a measure of worker independence — has been falling, dropping to 2.2 percent from a postpandemic high of 3 percent. 

Likewise, the ratio of open jobs to job seekers has fallen over the last two years from two open jobs for every job seeker to fewer than 1.5 open jobs.

Wages and salaries are slipping

Even as profits are jumping and inflation is sticking between 3 and 4-percent annual growth, wage growth has been falling for two years, a trend that continues in the Wednesday CPI release.

Real average hourly earnings for nonmanagement employees dropped by 0.2 percent from February to March, the Labor Department reported, subtracting the 0.2-percent increase in earnings from the 0.4 percent jump in the CPI.

Nominal earnings for nonmanagers has fallen from 7 percent growth in 2022 to 4.2 percent growth in March.

“There is now less competition to hire workers — and therefore less need to boost wages,” Nick Bunker, U.S.-based director of North American Economic Research at Indeed, told the BBC.

“Job postings have dropped quite a bit, while the supply of workers has grown.”

Fed officials were already questioning rate cut timing

Both markets and Fed officials had been signaling before the Wednesday inflation data that interest rates may stay higher for longer.

“It is too soon to say whether the recent readings represent more than just a bump,” Fed Chair Jerome Powell said at an event last week, prior to the release of the most recent CPI data. 

“We do not expect that it will be appropriate to lower our policy rate until we have greater confidence that inflation is moving sustainably down toward 2 percent.”

Atlanta Fed President Raphael Bostic suggested last week that rate cuts could come no sooner than the fourth quarter.

“If the economy evolves as I expect, and that’s going to be seeing continued robustness in GDP, unemployment and a slow decline of inflation through the course of the year, I think it would be appropriate for us to start moving down at the end of this year — the fourth quarter,” he said on CNBC.