According to data from the Bureau of Labor Statistics on Wednesday, the annual U.S. Consumer Price Index rose 4.9% in April, vs. expectations of a 5% increase. The lower-than-expected reading raised hopes that the Federal Reserve’s interest rate hiking cycle might be close to an end.

The core reading, which strips out volatile items like food and energy and is closely watched by the Federal Reserve, eased to 5.5% year-on-year from 5.6% in March. On a month-on-month basis, both the headline and the core inflation figures increased by 0.4%, which according to the Bureau of Labor Statistics was due to an uptick in costs for shelter and used cars.

The inflation data is indicating that inflationary pressures are easing, which suggests the Federal Reserve would be at the end or near the end of its interest rate tightening cycle. The initial market reaction was positive despite inflation being well above the Fed’s target rate of around 2% to achieve stable and sustainable growth.

Following a 25-basis point hike last week, the Federal Reserve’s benchmark interest rate is now at a range of 5% – 5.25%, up from almost zero at the beginning of last year. The Fed has indicated that it may pause on the tightening campaign in June, however it left the door open, with Fed Chair Jerome Powell noting that is «prepared to hike more» if further tightening of monetary conditions is necessary.

Futures markets are pricing in the Federal Reserve to start rate cuts this summer. While inflation is clearly decelerating, it’s not decelerating fast enough to justify cutting the Fed funds rate before the last quarter of 2023.

Complicating the decision-making process for the Fed is the resilience of the U.S. labour market, despite the aggressive rate hikes over the past year. The U.S. economy added 253,000 jobs last month, beating projections of 180,000, while the unemployment rate edged down to 3.4%, near a 50-year low.

The labour market remains tight, with 1.6 job openings for every unemployed person in March, which is well above the 1.0-1.2 range that is perceived as not generating much inflation.

Inflation is likely to continue to decline over the next few months but given the resilience of the labour market it could take awhile to fall back to the Fed’s 2% target. While the U.S. labour market is starting to lose momentum as more workers than expected apply for first-time unemployment benefits, it is still a long way from achieving the type of softening needed to sustainably bring inflation to Fed’s desired level.

The Labor Department data showed on Thursday that initial unemployment claims increased by 22K to 264K in the week ended May 6. Applications for U.S. unemployment benefits rose to the highest level since October 2021, showing that the labour market is gradually cooling.

A deterioration in the labour market would be evident when unemployment benefits claims rise to the 270K-300K range, with economists expecting these levels to be reached in the second half of the year.

Last week’s surge in jobless claims could mark the start of an upward trend as the cumulative and lagged effects of the Fed’s rate hikes transpire into the economy. Layoffs, which were initially concentrated in the technology and housing sectors, appear to be spreading to other industries as companies gear for weaker demand.

Source: Tradingview, S&P 500 Index Yearly Chart

The Fed is hoping to achieve a soft landing — lowering growth just enough to bring inflation under control without causing a recession. However, economists are sceptical, with many expecting the U.S. to enter a recession later this year.

Signs of an economic slowdown across the globe, lingering worries over the U.S. debt ceiling and fears of a deepening banking sector crisis have kept investors risk averse and on the side-lines over the past month.

The U.S. benchmark index continues to lack direction and trades in a narrow range reflecting the overall investor’s mood. The index has been fluctuating between 4,048 and 4,186 for four weeks in a raw showing a great deal of indecision among market participants. While the up-trend line on the RSI indicator still holds, readings remain below 70%, suggesting that the rally from the October 2022 low may be part of a wider trading range. Therefore, until key resistance of 4,325 is decisively cleared, we can not declare the bear market is over.

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