Next week, will inflation data surprise again? Standard Chartered: US April CPI may bring a "pleasant" cool down surprise

Last month, the year-on-year growth of the US CPI in March exceeded expectations, with a month-on-month growth rate higher than expected for the fifth consecutive month. The core CPI growth rate for three months also surpassed expectations, severely impacting market expectations for interest rate cuts. Following the meeting last week, Federal Reserve Chairman Powell denied the likelihood of a rate hike in the next step, but the signal conveyed indicates increased uncertainty regarding rate cuts. Journalist Nick Timiraos, also known as the "New Fed Communication Agency", subsequently wrote that the market no longer considers the Fed's inclination as crucial, but rather focuses more on economic and inflation data.

After the Fed meeting, the heavyweight inflation data of April CPI to be released next Wednesday will set the tone. Will the CPI once again grow faster than expected, shaking market confidence in rate cuts? Steven Englander, Chief Foreign Exchange Strategist at Standard Chartered Bank, recently pointed out in a report that by closely monitoring housing costs, especially housing inflation-related indicators in the CPI such as Owner's Equivalent Rent (OER), there are reasons to be optimistic that housing inflation may soon decline, thereby pulling down core inflation.

Powell appeared confident after the meeting last week that the potential decrease in future housing costs could reduce core inflation. As shown in the graph below, Englander conducted a regression analysis on actual and predicted OER, finding that "Powell's optimism may be justified" as the analysis indicates a "sharp decline in OER in the coming months" based on stable regressions in recent years.

Englander's analysis is based on a new series of experimental rents for new tenants and all tenants constructed by researchers from the Fed and the Bureau of Labor Statistics (BLS), which can provide good out-of-sample forecasts for OER even estimated between 2012 and 2019. The regression results suggest that the abnormal rise in OER in the first quarter of this year will face downward pressure in the coming months, with the downward pressure potentially being "sharp".

Englander predicts that the average OER inflation in the second quarter will only increase by 0.29% compared to the previous quarter, which is not far from the general range seen from 2015 to 2019, showing a slowdown from the 0.48% quarter-on-quarter growth rate in the first quarter of this year. This is a significant change because OER accounts for 33% of the core CPI, so a slowdown in the forecasted growth rate of OER will lead to a 0.06 percentage point decrease in the quarter-on-quarter core CPI, meaning that if more components of the CPI experience cooling inflation, the core CPI growth rate may be 0.3% lower than expected, slowing to 0.2% or even lower.

Englander's analysis of OER tracks data on market rents in the private sector, which has recently declined. He believes that OER inflation will continue to be weak in the coming quarters His conclusion is that this OER slowdown will motivate people to expect that inflation will restart its downward trend, and the decline is sufficient to prompt the Fed to start cutting interest rates.

At the same time, Englander pointed out that his conclusion has two major risks. First, the experimental data on new tenants and all tenant rents from the BLS and the Fed are released quarterly, so his judgment on quarterly changes may be correct, but his judgment on monthly changes may be incorrect. Last year, the BLS changed its calculation method, which means that OER is currently estimated based on a small sample of single-family rental homes, leading to the possibility of random fluctuations in OER data. Second, a significant demand for single-family homes may cause rents to rise disproportionately and continue to rise in this way. However, most landlords have locked in lower mortgage rates and will not face increased housing costs.

Englander mentioned that he noticed a statement made by Powell last week: Given the current market rents, I still expect these rents to be reflected in measurable housing services inflation over time. Englander pointed out that, considering the high OER inflation in the first quarter, Powell's confidence in housing inflation surprised him. Moreover, Powell seems to no longer focus on the so-called super-core inflation - excluding food, energy, and housing rents, but instead focuses on the declining rent inflation as a sufficient reason for rate cuts, which also surprised him