Has the market overreacted to the US March CPI data?

There is a strange practice in financial markets: investors are "shocked" when economic data do not match forecasts, even though few believed them at first. That was the case with last week's US inflation data.

Previous data showed that CPI in the United States increased by 3% in March compared with the same period last year.Crashtwinsanityps4.5%, higher than expected 3.4%Crashtwinsanityps4Core CPI rose 0.4% month-on-month in March, higher than the expected 0.3%. A higher-than-expected 0.1% triggered a frenzied repricing of expectations of a Fed rate cut in 2024.

To be sure, it is entirely reasonable for investors to think that the Fed's position on three interest rate cuts in 2024 may change (as Powell hinted on Tuesday). But adjusting interest rate expectations based on inflation forecasts with little confidence-from three interest rate cuts to one or no-seems problematic, and digging deep into the data supports this view.

Housing has always been the focus of the market in subdivided projects. However, in CPI statistics, housing is actually driven by the "equivalent rent of residential homeowners" (OER). This is the Bureau of Labor Statistics's estimate of the rent that owners of self-occupied homes will have to pay if they rent their house. It accounts for up to 34 per cent of the core CPI (excluding food and energy).

But OER's calculation itself is questionable: first, it is based on rents similar to rental housing. Second, it includes the EU HICP and UK CPI indicators used by the ECB and the Bank of England-none of which is included.

OER accounts for a much lower proportion of the Fed's preferred measure of PCE inflation: the core PCE only gives it a 13% weight, and less emphasis on OER gives PCE a more accurate picture of inflation.

Paul Donovan, chief economist of global wealth management at UBS, commented:

Because OER is completely fictional, the real cost of living for homeowners is milder than CPI suggests.

The Fed now seems to be caught in a trap: after raising the importance of CPI as a measure of inflation, the current discussion of interest rate cuts has become difficult. But if you look at PCE indicators, the picture is much more optimistic: inflationary pressures on housing, labour and so on are easing, which means that core PCE should also ease further.

Given the constraints of real interest rates, the weakness of the economy and the location of potential inflation, the Fed may still need to cut interest rates. But given Powell's comments this week, the Fed is more likely to cut interest rates later this year and by less.

This article comes from Wall Street News, written by Xu Chao, financial editor of Zhitong: Chen Qiuda.