Hot Inflation Report Shifts Fed Expectations Away From Rate Cuts Toward Possible Hikes

Inflation Accelerates Beyond Expectations

April's hotter-than-expected inflation reading is likely to put the Fed on watch for higher energy costs creeping into other prices, with the Consumer Price Index rising 3.8% in April compared with expectations for a rise of 3.7%, with energy prices accounting for 40% of the increase. The Producer Price Index report showed the war with Iran is raising costs for US businesses at a rate not seen in nearly four years, with PPI increasing in April to 6% on an annual basis from 4% in March, and on a monthly basis the index increased 1.4%.

Market Repricing: From Cuts to Hikes

Following a hotter-than-expected inflation report, market pricing took virtually any chance of a cut off the table between now and the end of 2027, with traders instead pricing in a better than 1-in-3 chance of an increase by the end of this year. Higher-than-expected April inflation of 3.8% year-over-year, driven 40% by energy prices amid Middle East tensions, has shifted market expectations from multiple Fed rate cuts to a 27% probability of a rate hike before 2028.

New Fed Chair Faces Difficult Path

The hawkish market expectations pose a particular challenge for incoming Fed Chair Kevin Warsh, who is expected to take the reins this month and has been outspoken in favor of cutting rates, but Warsh will "not see how he's going to get any kind of support for cutting interest rates in the current environment."

Inflation Broadening Across Economy

Core inflation clocked in at 2.8%, compared with expectations of 2.7%, with services inflation excluding energy up 3.3%, while goods prices, which have been pushed higher by tariffs, rose 1.1%.