February inflation cooled but remained elevated as total Consumer Price Index inflation decelerated to 2.8% from 3% and core CPI inflation decelerated to 3.1% from 3.3%. Due to easing year-on-year consumer inflation rates, a recent tepid jobs report, and downside risks from tariff and trade policy uncertainty, an interest rate cut by the Federal Reserve looks very likely by the midyear. Plus, if year-on-year CPI inflation rates ease further, expectations for Fed rate cuts could increase. The official Fed member forecasts of future interest rates on March 19 will be watched closely for market implications.
Total CPI Consumer Inflation Decelerated In February
The risk landscape for interest rates improved following decelerations in consumer inflation in the February CPI inflation report. It showed a deceleration in year-on-year total CPI and core CPI. Easing inflationary pressures are welcome for market participants and business leaders eager to see interest rates fall. The February CPI report brought a welcome easing of inflationary pressures that ran hot in January.
In addition to decelerations in year-on-year total CPI and core CPI, there were only modest month-on-month inflation increases. Total CPI was up by 0.2%, and core CPI, which excludes food and energy, was also up by 0.2% in February. These easing month-on-month inflationary pressures increased the potential for base effects to pull down year-on-year consumer inflation rates, and they improved the probability of a Fed rate cut by the midyear.
Consumer Inflation Implications For Fed Policy
The December 2024 Federal Open Market Committee projections for the federal funds rate reflected expectations of only two 0.25% rate cuts by the end of 2025. Prestige Economics previously predicted that this forecast likely understated the potential number of Fed rate cuts for 2025.
Prestige Economics had expected an easing in February year-on-year total CPI and core CPI inflation rates. However, year-on-year inflation rates are still sticky and well above the Fed’s 2% target. Nevertheless, slowing month-on-month and year-on-year CPI rates in this report are conducive to a Fed rate cut by the June 18 Fed meeting.
According to the CME FedWatch Tool, the probability of a March Fed rate cut remained very low at only 3% as of 8:46 a.m. ET following the release of the February CPI report.
The odds of a May 7 Fed interest rate cut were 34.4% on March 12 at 8:46 a.m. ET, immediately after the release of the CPI report, according to the CME FedWatch Tool.
The odds of a June 18 Fed interest rate cut were 77.1% on March 12 at 8:46 a.m. ET, immediately after the release of the CPI report, according to the CME FedWatch Tool.
Given these probabilities, a June Fed rate cut looks very likely, while a May Fed interest rate cut appears unlikely. However, the Fed is data-dependent. If year-on-year CPI and Personal Consumption Expenditures consumer inflation rates ease further or if growth weakens more significantly, markets could begin to price in a May Fed rate cut as well.
Inflation Implications And Risks For Financial Markets
A Fed interest rate cut still seems unlikely before June. However, multiple interest rate cuts are likely in 2025 and 2026. In the immediate term, financial markets are likely to move on the fact that the February CPI report showed decelerations in total and core CPI, which is indicative of more rate cuts in 2025.
Bond yields and the dollar are likely to fall on the back of this report due to solid expectations for Fed rate cuts against a backdrop of tepid U.S. jobs and downside growth risks.
Equities, bond prices, and industrial commodities prices are likely to find some support in the wake of this report despite significant trade risks and rising recession fears.
The next critical reports with potential Fed policy implications will be the February Producer Price Index report on March 13 and the March preliminary release of the University of Michigan Consumer Sentiment release on March 14.
Next week, analysts, economists, and investors will be closely watching the March 19 Fed meeting, which will include a publication of the Federal Open Market Committee member projections for the future of U.S. growth, unemployment, inflation, and interest rates.
Read the full article here
