Key Takeaways
- The March Consumer Price Index (CPI) rose +0.9% month over month—the largest increase since 2022—showing that the war-related surge in gasoline prices is already pushing headline inflation higher and resetting near-term market expectations.
- Core CPI was more contained at +2.6% year over year, but the March reading ended its recent disinflation trend, reminding investors that underlying price pressures remain above the Fed’s comfort zone.
- With core personal consumption expenditures (PCE) already at +3.0% prior to the March energy shock, the Fed appears likely to remain in a holding pattern, looking through energy-driven inflation and leaving rate cuts near the end of this easing cycle.
The Middle East war has replaced tariff-driven inflation concerns with fears of rising energy prices feeding through the economy. On Friday, the Bureau of Labor Statistics (BLS) released its March CPI report, when markets received their first ‘official’ glimpse of how the surge in energy prices has begun to impact the U.S. inflation setting.
The numbers came in close to consensus estimates. But, the elevated headline reading, in particular, marked notable milestones. The monthly gain for overall CPI came in at +0.9%, the largest jump since 2022. Meanwhile, the year-over-year increase registered its highest level in about two years.
Read more: Weighing the Impact of the Middle East War
This nearly full percentage-point increase in both the monthly and annual readings reflected the war-related surge in crude oil prices, particularly in gasoline prices at the pump. In fact, gasoline prices, as measured in the CPI report, recorded its largest increase since 1967.
Against this backdrop, what about the ‘core’? CPI, excluding food & energy, was far tamer, coming in with a year-over-year gain of +2.6%. However, the March increase interrupted a bout of disinflation for the core gauge and represented the first increase since July.
Extending the core inflation analysis, although core CPI had been returning to a more disinflationary pattern prior to March, it still remained above the Fed’s preference. That brings us to the Fed’s preferred inflation gauge, the core PCE deflator. Unlike core CPI, this measure has actually been trending to the upside on a pre-war basis. Indeed, the year-over-year reading stands at +3.0% as of this writing. This figure is a full percentage point above the Fed’s 2% target. This reading reflects February data, prior to the Middle East war. The March PCE data won’t be released until the end of this month (scheduled for April 30), and it is reasonable to expect not only the headline PCE deflator to jump, but also the core measure remaining above the Fed’s target.
Conclusion
If the Middle East war moves into a more permanent de-escalation phase, or ends, we would expect energy prices to decline meaningfully. However, the scope of disruption has moved higher, and energy prices may not be able to return to pre-war levels in the months immediately ahead.
In our opinion, the Fed will attempt to ‘look through’ the recent surge in energy prices. This development has created a noteworthy shift in inflation fears, but the policymakers, at this point, seem to be operating under the assumption that any elevation in price pressures from higher energy costs will not be a permanent development. Powell & Co. will be loath to use the term ‘transitory’.
Given the war-related uncertainty and the recent jobs and inflation reports, the Fed appears to be in a holding pattern. The most important takeaway is that financial markets will operate in a scenario in which rate cuts are either near or at the end of this easing cycle.
Kevin serves as the Head of Investment and Fixed Income Strategy.
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