March CPI: Sunset in the rearview mirror

Summary

The CPI data were unexpectedly soft in March and give the FOMC a bit of breathing room as policymakers grapple with the appropriate stance of monetary policy amid significant economic uncertainty. Consumer prices declined 0.1% last month, the largest monthly drop since May 2020. A 6.3% decline in gasoline prices helped push headline inflation into negative territory. But, even excluding food and energy, the March inflation data were quite cool. Core CPI rose 0.1% (0.06% unrounded), the smallest increase since January 2021. Big declines in some of the more volatile travel-related components contributed to the slowdown, with deflation for airfares (-5.3%), lodging away from home (-3.5%) and used autos (-0.7%). Our initial read on the pass through to the core PCE deflator, the Fed's preferred inflation metric, suggests a 0.1% print in March when the data are released in a couple of weeks.

Taking a step back, gradual progress on the inflation front has continued in recent months, despite the frustratingly slow pace of improvement and the periodic bumps in the road. The core CPI has risen 2.8% over the past year, a four-year low and 100 bps lower than the rate that prevailed one year ago in March 2024. The question facing FOMC officials is whether inflation will start rising again in the face of a historic increase in the average tariff rate on U.S. imports. Even with President Trump's 90-day pause on reciprocal tariffs, the numerous other tariff increases (10% universal + 125% on China + steel, aluminum, autos, etc.) leaves the average effective tariff rate at the highest rate in a century. As discussed in our April U.S. Economic Outlook, our current working assumption is that the year-over-year rate of core CPI will be back to nearly 4% at the end of the year.

Our expectation is that when push comes to shove, the FOMC will cut the federal funds rate to limit damage to the labor market, even if inflation moves higher in the months ahead. We project the federal funds rate to be 125 bps lower by the end of the year amid a modest rise in the unemployment and economic growth that is near zero for the year.

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