March Inflation Report: Disinflation May Have Finally Arrived

Earlier today, the Bureau of Labor statistics released the Consumer Price Index for March. Headline inflation rose 5.0% year over year, which was notably better than the 6% reading of a month ago. Core CPI, which is inflation without food and energy, was at 5.6%, a tick higher than the 5.5% recorded last month. Due to the 100-basis point drop in headline inflation, combined with headline dropping below core, I believe the Fed has finally achieved disinflation, but several sticky pricing items remain.

The drive to lower headline inflation was led by non-durable goods, which went from a 6.4% year-over-year increase to 2.8% in just one month. Energy, a component of nondurable goods, declined by 6.4%. While these may be considered by some to be one-off type numbers, it's important to note that the year over year price declines in durable goods have remained for four straight months, also helping to push inflation down.

It also appears as if inflation will continue to decline in the near term as the 0.9% month over month reading of last May and 1.2% reading last June will roll off the annual inflation calculation over the next three months. By looking at nearer-term data, it appears as if recent reports would suggest inflation heading toward 4.6% with core inflation staying at or slightly above those levels.

While the progress being made shows that the Federal Reserve rate hikes are working, it does not mean the Fed should reverse course anytime soon. There are still sectors of the economy that are contributing significantly to inflation. These sectors would become impossible to achieve price stability within should the Federal Reserve decide to reverse course.

One area is housing, which despite a slight drop to 7.8% in March, remains above 7% for the tenth consecutive month and only 50 basis points off the business cycle high. Rent remains at a business cycle high of 8.8%. Should the Fed reverse course, it would make an already inflated asset bubble in the housing sector far worse.

Like housing, pricing in the services sector remain stubbornly high. After recording a business cycle high of 7.3% last month, the sector finally saw a decline to 7.1% in March, breaking a streak of 18 consecutive months where inflation rose in the sector. Housing and services will be the two sectors I will continue to watch in future months as their direction will determine whether disinflation is in full effect.

The market continues to hold onto the belief that the Fed will cut rates before the end of the year. Currently, the December contract for Fed fund futures implies between 1 and 2 rate cuts (of 25 basis points each) between now and the end of the year. This is almost 100 basis points higher than where it was at the height of the regional banking crisis, but the markets are still irrationally pricing in Fed easing.

Overall, I think we have finally turned the corner in the battle against out-of-control inflation. I think the Fed's forecast of one more rate hike, then hold is prudent to monitor the progress of overall pricing, but also to see if services and housing start to stabilize. While inflation stalling at 4% to 5% per year is a better scenario than 8% or 9% and rising, the Fed remains committed to the long term rate of 2% and policy will continue to be centered around that goal.