The Federal Reserve is widely expected to forgo an interest rate hike this week, pausing a 15-month campaign during which it jacked borrowing costs to crush runway inflation.
Government data released Tuesday morning showed the consumer price index, a key measure of inflation, rose 4% in May from the previous year, marking a small increase since March 2021.
Although inflation remains about twice the Fed's preferred target rate of 2%, the slowdown gives officials fodder to skip what would be the 11th straight rate increase.
The probability that the Fed pauses its tightening cycle jumped to 92% Tuesday afternoon, up from 71.9% the previous day, according to data from the CME Group's FedWatch tool, which tracks trading.
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"This CPI report is everything the Fed needs to pause. There is deflation and/or disinflation in every category," said Jamie Cox, managing partner at the Virginia-based Harris Financial Group. "Even the stickiest parts of the dataset, namely rents, have reached an infection point."
Several Fed officials, including Chair Jerome Powell, have hinted the central bank will hold rates steady at the current range of 5% to 5.25% to give policymakers time to evaluate the broader economic impact of 10 consecutive hikes.
"Having come this far, we can afford to look at the data and the evolving outlook and make careful assessments," Powell said during a Fed research conference in May.
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However, a handful of more hawkish officials — including St. Louis Fed President James Bullard and Cleveland's Loretta Mester — have hinted they are open to raising rates for the 11th straight time in June, opening the door to a rare dissent.
"There will be some hawks who dissent tomorrow on a pause, but that’s where the Fed is going," Cox said. "If this trajectory holds in June, the need for further tightening is behind us."
But Wall Street is even more focused on Powell's press conference at 2:30 p.m. ET for additional clues about what comes next in the Fed's inflation fight. Powell may leave the door open to at least one more rate hike this year depending on upcoming economic data releases, including the next CPI report due in July.
Economists are divided over whether the Fed will resume rate hikes over the summer, or whether the current range of 5% to 5.25% represents the peak. Roughly one-third of respondents are bracing for an 11th rate hike in July.
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Although inflation has eased from a peak of 9.1%, it remains about more than double the pre-pandemic average and well above the Fed's 2% target rate, underscoring the persistent financial burden high prices have placed on millions of U.S. households. Core prices also pointed to strong underlying price pressures that are still bubbling beneath the surface.
On top of that, the labor market remains uncomfortably tight, defying expectations for a slowdown.
The government reported last week that employers added 339,000 jobs in May, nearly twice what economists projected, even in the face of higher borrowing costs, chronic inflation and declining economic growth. At the same time, the unemployment rate unexpectedly jumped to 3.7% from 3.4%, even though the labor force participation rate remained unchanged last month.
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It was the highest jobless rate since October 2022 and the biggest increase since the early days of the COVID-19 pandemic.
Economists are split over whether another rate increase is possible this year or whether the central bank is done raising rates altogether.
"A rate hike is still possible in July or the following decision in September, but the Fed looks slightly more likely to hold rates steady in its next few decisions," said Bill Adams, chief economist for Comerica Bank. "It is a close call."
