Market Anticipates Significant CPI Deviation; Morgan Stanley Economist Concurs

Market Anticipates Significant CPI Deviation; Morgan Stanley Economist Concurs 

Last week, before the release of this week's significant CPI report on Wednesday, we discussed why we anticipate a substantial deviation in the CPI figure. Essentially, the component of the CPI basket related to Owner's Equivalent Rent (OER) is falling behind the current decline in rents, leading to an expected significant shortfall in core CPI figures. This mismatch is likely to result in one or more months of rapid adjustments as core CPI unexpectedly misses the mark by a large margin.

Morgan Stanley's chief economist, Seth Carpenter, concurs with this outlook. He notes that the Bureau of Labor Statistics (BLS) typically spreads changes in current rents over several quarters in its calculations. With current rent readings showing a significant decline, Carpenter predicts a continued drop in official statistics throughout the year. This prediction aligns with the observation that despite increased immigration, multifamily vacancies are nearing historical highs. This housing inflation trend strongly indicates a downward trajectory for overall inflation.

The upcoming CPI release on Wednesday, scheduled for 8:30 am New York time, is highly anticipated by market participants worldwide. The Federal Reserve has made it clear that inflation is the primary factor preventing them from implementing rate cuts. While the market initially expected numerous rate cuts earlier in the year, current expectations have been adjusted to under two cuts, likely starting in September.

Regardless of the CPI print on Wednesday, the forecast indicates a downward trend in inflation over the year, prompting speculation not about whether the Fed will cut rates, but when. Even if the April CPI figures do not reflect a significant change, core CPI is anticipated to decrease slightly, driven by a gradual decline in rent inflation and minor decreases in core goods prices.

A critical aspect to monitor in Wednesday's report is rents, which heavily influence housing inflation, comprising a substantial portion of core CPI and core PCE. As current rent readings continue to show weakness, it's expected that official statistics will reflect a continued decline throughout the year.

Inflationary pressures outside of housing, particularly in services, have shown some signs of increase, notably in portfolio management and investment advice services. However, these components are subject to volatility, often influenced by equity price fluctuations. Car insurance premiums have also exhibited consistent inflation, but this trend is attributed to insurance companies adjusting for past higher costs and is expected to diminish over time.

Additionally, it's noted that seasonal adjustments may have exaggerated inflation in the first quarter of the year, implying a potential corrective adjustment later. Considering all these factors, the consensus is that inflation will decrease over the year, prompting the Federal Reserve to commence rate cuts as inflation declines.