Nick Timiraos, a well-known financial journalist known as the “New Federal Reserve News Agency,” wrote that the US economic activity report released on Thursday brought investors and Fed policymakers the latest unpleasant warning. They had expected that slowing economic growth and cooling inflation would allow the Federal Reserve to start cutting interest rates this summer, but in fact, the opposite was true.

According to data released by the US Department of Commerce, the US real GDP annualized for the first quarter increased 1.6% from the initial quarterly value, falling short of the 2.5% expected by the market. This is a sharp drop from 3.4% in the fourth quarter of last year, but the broader potential demand index is close to 3%, indicating that the momentum is still strong.

In terms of quarterly inflation data released at the same time, personal consumption expenditure (PCE) annualized quarterly increased by 2.5% compared to the initial value, a sharp decrease from the previous value of 3.3%, and lower than the expected 3%. However, the core PCE price index, which excludes food and energy, grew 3.7% quarterly, exceeding expectations by 3.4%, almost double the previous value of 2%. This is the first quarterly increase in a year, highlighting that core inflation is still stubborn.

Timiraos pointed out that the latest data shows that after experiencing a perfect cooling in the second half of last year, US inflation proved to be more stubborn than expected, and data for three consecutive months have confirmed this. Individual data is not enough to drastically change the Fed's outlook, but the cumulative effect of these continuous disappointing data is significant. In particular, the inflation data has been stronger than expected, and there has also been an increase in data in recent months.

Recent inflation trends in the US have led investors and Federal Reserve officials to reconsider whether it is appropriate to cut interest rates this year:

• Chicago Federal Reserve Chairman Goulsby said last week, “I've always said that a month is nothing, but three months—that at least counts as a real month. Now, after six or seven months of very strong improvements and inflation closer to 2%, we're seeing data well above our target, and we have to readjust our minds and wait and see what happens. As the supply chain repairs and the labor market benefits from the influx of workers, the Fed's inflation battle has been straightforward, but this year will definitely be even harder.”

• Analysts are also continuously reducing their expectations on how many times the Federal Reserve will cut interest rates this year, and they are also postponing their predictions for when they first cut interest rates. Some analysts now expect to cut interest rates only once at the December meeting. Although they still believe that inflation is moving towards the 2% target, the Federal Reserve is also moving in the direction of cutting interest rates, and will cut interest rates this year, so it is unlikely that the next step will be to raise interest rates. However, admittedly, the risk is turning again, and interest rate cuts will be less frequent this year, and the time will be even later.

• The market generally agreed with this view. Investors in the interest rate futures market anticipated six interest rate cuts at the beginning of the year, but now many people expect only one, or none at all. After the latest data was released on Thursday, US bonds were sold off. The benchmark 10-year US bond yield broke 4.7% for the first time since November last year. At that time, Federal Reserve officials had not yet indicated that they had completed raising interest rates.

The US Department of Commerce will release the March core PCE price index on Friday. Thursday's report indicates that the relevant data for January and February may be further revised from the already strong level, and may rise in March, and the 12-month inflation rate remained around 2.8%.

Timiraos mentioned that some people said that the rebound in US stocks at the end of last year, driven by expectations of interest rate cuts, may have boosted the prices of financial management services included in the inflation index.

Timiraos said that the Federal Reserve has been paying special attention to monthly inflation data, partly because it has been difficult for the Federal Reserve and the entire economics community to predict inflation since the COVID-19 pandemic. Many people didn't anticipate how much inflation would rise in 2021 and 2022, and they were also surprised that inflation cooled rapidly last year, particularly as employment and spending remained steady.

Officials have been saying since the end of last year that they may start cutting interest rates, provided that price growth slows to around 2.5% later this year before reaching the 2% inflation target. In the third and fourth quarters of last year, the core PCE index rose at an annual rate of 2%, which strengthened optimism that the Federal Reserve might end the fight against inflation.

Many Federal Reserve officials, including Federal Reserve Chairman Powell, initially classified the higher inflation data for January and February as “bumps” on the path to cooling inflation. At the press conference of the March FOMC meeting, Powell said the data didn't really change the overall situation.

Powell also acknowledged the limitations of his ideas. “I'm always careful not to dismiss data we don't like. So you need to check yourself and I'll do it.” Powell said last week that strong inflation data for March may have delayed the schedule for starting interest rate cuts by several months.

US core inflation reached a high of 5.6% in February 2022 and began a steady decline a year ago. The latest inflation report has revived concerns that the so-called “last mile” of pulling inflation back completely to 2% will be even more challenging. Some Federal Reserve officials said they are worried that interest rates will stay too high for too long, causing unnecessary harm to the labor market.

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