Easing Consumer Inflation Could Raise Hopes Of Fed Interest Rate Cuts

Consumer inflation is one of the most important economic reports this week. Given the downside risks to growth, a recent tepid jobs report, and falling confidence on the back of tariff and trade uncertainty, easing inflation could give the Federal Reserve the license it needs to cut interest rates sooner rather than later.

Consumer Inflation Is The Fed’s Top Priority

This week’s release of the February Consumer Price Index report follows a hot pace of year-on-year inflation rates in January when total CPI was 3% and core CPI was 3.3%. The Fed’s consumer inflation target is 2%. Fortunately, the January Personal Consumption Expenditures inflation rates were at more benign year-on-year rates of 2.5% for total PCE and 2.6% for the core PCE.

The Fed’s dual mandate is low, stable prices and full employment. While prices remain elevated, the labor market is still quite solid, despite a tepid February jobs report that showed a rise in the unemployment rate to 4.1% and payroll gains of only 151,000.

In the week ahead, Prestige Economics expects modest month-on-month CPI inflation in the February report that will likely be accompanied by decelerations in the year-on-year total CPI and core CPI inflation rates.

Inflation Outlook And Market Interest Rate Expectations

According to the CME FedWatch Tool, the probability of a March Fed rate cut is effectively zero at only 3% as of March 11 at 3:17 p.m. ET.

The odds of a May 7 Fed interest rate cut is 38.9% as of March 11 at 3:17 p.m. ET, and the odds of at least one June 18 Fed interest rate is 86.3% as of March 11 at 3:17 p.m. ET, according to the CME FedWatch Tool.

While the latest jobs report was tepid, consumer confidence has been under pressure. If inflation eases in the CPI report this week, the CME FedWatch Tool is likely to show even higher odds of May or June Fed rate cuts.

Consumer Inflation Market Implications

Downside growth risks have increased due to trade and tariff policy uncertainty and persistently high interest rates. Fortunately, a Fed interest rate cut seems very likely in or before June, and additional interest rate cuts are likely in 2025 and 2026. If interest rates fall, it would support the growth outlook and manufacturing activity.

Elevated trade risks have also weighed on equity markets recently. On the upside, if the year-on-year February total CPI and core CPI inflation rates ease, the Fed would have more of a license to cut interest rates, supporting equity, bond, and industrial commodity prices while the dollar comes under pressure.

On the downside, if year-on-year inflation rates remain elevated, the Fed may struggle to justify cutting interest rates unless there is a more severe slowdown in economic activity.

This week’s data also includes the first glimpse of March confidence, with the preliminary release of the University of Michigan Consumer Sentiment. If this report weakens from February levels, the growth outlook could sour further, raising the odds of a May Fed rate cut. However, if confidence improves, the odds of a May Fed rate cut would likely fall.

Despite the downside risks to confidence and growth, year-on-year consumer inflation rates will be the most critical factors that shape the future of Fed monetary policy.