The U.S. core Consumer Price Index (CPI) recorded another soft print in April, at 0.07% month-over-month, following
very weak results in March (-0.122%). But unlike in March – when weakness
was primarily attributable to the largest-ever monthly decline in wireless
services – April’s weakness was broad-based, reflecting softness in a range
of core goods and services. As a result, we’ve reduced our 2017 year-end
core U.S. inflation forecast to 2.0% from 2.3%. Negative residual
seasonality, which tends to be a drag in the latter half of the year, may
be a headwind to our forecast and could further moderate the rate for
fourth-quarter 2017 relative to the same quarter last year.
The noticeable softening in inflation increases the pressure on Federal
Reserve policymakers to explain their presumed plan to hike interest rates
in June. While still-easy financial conditions and a 4.4% unemployment rate
could help the Fed craft a coherent story for June, continued weak
inflation could complicate further hikes later this year. Based on this
report and the latest Producer Price Index (PPI), we calculate that the
year-over-year rate of personal consumption expenditure (PCE) inflation
could fall to 1.4% in April from 1.6% in March, and we now believe it will
be closer to 1.5% at the end of fiscal 2017. This compares with the Federal
Open Market Committee (FOMC) median projection of 1.9%.
No single smoking gun, though core goods disappoint
Both new and used auto prices declined further in April after falling last
month, in what appears to be the start of a more meaningful trend. Industry
reports indicate that an increase in vehicle leases over the past several
years has created a glut of used autos. This is pressuring wholesale
used-car auction prices, which tend to lead the CPI by around three months.
Other core goods were also soft in April, with recreational goods,
furnishings and apparel showing declines. China consumer goods price trends
and the exchange rate can have a meaningful impact on these prices.
However, despite an acceleration in the China PPI last year, a closer look
reveals that price pressures were concentrated in industrial metals, which
are unlikely to affect the U.S. CPI (although they will likely influence
U.S. PPI and import prices). Finally, medical goods prices fell in April on
the largest-ever decline in prescription drugs prices, likely due to major
drugs going off patent.
Core services languish
Core services inflation was also below trend in April, at +0.14%, after a
0.06% drop in March resulting from the plunge in wireless services. Rents
(+0.3%) and owner’s equivalent rent (OER) inflation (+0.23%) were
consistent with our forecasts for some modest deceleration. Rents in the
largest 10 cities continue to moderate in line with the glut of multifamily
housing supply, but outside those cities, low inventory of affordable
housing continues to support a firmer 3.5% year-over-year pace of rental
inflation. Meanwhile, medical service prices were weak in April due to the
largest-ever decline in physicians’ services, and transportation services,
recreation services and education were all flat to down.
In a nutshell, unlike in March, April’s soft inflation across a range of
core goods and services prices cannot be explained away by large, one-off
price adjustments or other quirks in the data. We’ve revised our U.S.
inflation forecast accordingly.
Readers interested in the interplay of inflation and rates can learn more at our Rise Above Rates page:
is a PIMCO economist focusing on the U.S. and is a regular contributor to the PIMCO Blog.