Transitory higher inflation but stable employment ─ the Fed may be on hold in 2026
·
Even if the SOH deadlock resolves by May, oil may
not fall below ₹80,
and the core CPI average for 2026 may be around 3.5%.
·
Even if US unemployment averages around 4.5%, the
Fed's red line in 2026, the Fed has to keep the present neutral rate (+1.0%
real positive wrt core CPI) to bring both inflation and unemployment down
towards targets.
On May 12, apart from Trump’s China visit and Iran
war/SOH (Strait of Hormuz) suspense, some focus of the market was also on U.S.
inflation data for April. The US CPI measures the average change over time in
the prices paid by urban consumers for a market basket of consumer goods and
services, such as food, transportation, and shelter. Core CPI excludes the
volatile food and energy categories to provide a clearer view of underlying
inflation trends.
On
May 12, the BLS data (NSA) show the annual (y/y) US core CPI inflation rose to 2.8% in April against 2.6% sequentially, higher than the median
market expectations of 2.7% and the sharpest rise since September '25 amid
higher costs for shelter/rent and transportation services.
The 3MRA core CPI rate is now around 3.2% against
2.9% (y/y). The 2025 average was 2.9% vs. 2.6% in 2026 (YTM). In Dec '19
(pre-COVID), the US core CPI was 2.3% against the core PCE of 1.5%; the average core
inflation (CPI + PCE) was around 1.9%, just below the Fed’s 2.0% target.
On
May 12, the BLS data (SA) also shows the sequential (m/m) US core CPI rose 0.4% in April '26 from 0.3% in
the preceding month and higher than the market expectations of 0.3%. The April
'26 sequential core CPI of 0.4% was the sharpest rise since Jan '25.
Overall,
the 3MRA of US core CPI is
now around 0.3% vs the YTM (2026) average of 0.3% and 0.2% in December '19
(pre-COVID).
In
April '26, the BLS data shows the US super core CPI inflation (w/o food, fuel/energy, shelter/housing, and used cars
& trucks) rose at 2.6% from 2.6% in the prior month, compared to 1.7% in
pre-COVID (Dec '19) times. The US Trimmed Mean CPI (Cleveland Fed) surged 2.6%
in April '26 against 2.6% the prior month and pre-COVID levels of 2.3%. New Fed
Chair Warsh may emphasize the Trimmed Mean CPI (TMC) more rather than the core PCE.
In
April '26, the US CPI increased by 3.8% against 3.3% in the prior month and 2.5% in
the prior year, and above the market expectations of 3.7%. The April spike in
total CPI of 3.8% was the sharpest since September '23 amid spiraling energy costs
(+17.9%) due to the Strait of Hormuz and the Iran deal deadlock.
The 3MRA of US CPI was 3.2% vs. 2.7% sequentially
and 2.5% yearly; the 3MRA in December '19 (pre-COVID) was 2.1%.
The
US food inflation was 3.2% in April '26 against 2.7% in the prior month vs. 2.0% in December
'19 (pre-COVID). US energy inflation soared to 17.9% in April '26 vs. 12.5% in
the previous month (sequentially) and -3.5% yearly (Apr '25). The US energy
inflation suddenly turned positive and zoomed due to the lower base effect, but
if the SOH blockade and Iran peace deal deadlock continue, the total CPI may go
past 4.5%. Usually, the US food CPI is always below the total CPI, but when it goes
higher, then the total CPI surges above the 3.5-4.0% Fed red line.
In
April '26, the sequential (m/m) US CPI increased by 0.6% from 0.9% in the prior month, in line with the
median market expectations of 0.6% and pre-COVID (December '19) levels of 0.3%.
The
3MRA of sequential total US CPI was around 0.6% vs. 0.4% in the prior month and 0.2%
in the prior year.
The
US service inflation was
at 3.4% in April '26 against 3.1% in the prior month and 3.7% in the prior
year. The 3MRA was 3.2% vs. 2.8% pre-COVID (December '19). The US rent/shelter
inflation was at 3.3% in April '26 vs. 3.0% in the prior month and 4.0% in the
prior year. The 3MRA is now 3.1% vs. 3.3% in pre-COVID times (December '19).
The US rent inflation was on a downward path since
August '24, when it became almost clear that with Trump 2.0, illegal or even
many legal immigrants started to leave the country, which accelerated after January-March
'25. But now, rent inflation may have bottomed out and may rise in the coming
days as a meaningful part of those illegal/legal immigrants may again return to
the US with proper documentation to fill the growing labor shortage,
especially in labor-intensive construction, manufacturing, and agricultural
sectors.
Conclusions
Overall, even if we assume a 0.3% sequential core
CPI rate for the next few months, the 12-month (y/y) core CPI rate would be
around 3.5% on average for 2026. The Fed, even under new Chair Warsh, who is
now sounding less dovish than earlier expected, may not be able to cut rates
under consistent pressure from Trump & Co. Assuming some pressure in
employment, even if unemployment rises to 4.5% along with core CPI of 3.5%, the
Fed needs to bring down core inflation by 150 bps to 2.0% targets and
unemployment rate to 4.00-3.5% by 50-100 bps as per its mandate of maximum
employment and price stability. Thus, the Fed has to maintain its current
policy of a neutral real rate of around 1.0% (wrt core CPI).
