US inflation climbs to 3.8% as Fed braces for persistent price pressures
The Federal Reserve is expected to hold interest rates through June and most of 2026, with markets pricing in a nearly 30% chance of an increase by year-end.
US consumer prices rose by 3.8% in April, surpassing the forecasted 3.7% increase and marking the second consecutive month of elevated inflation linked to the ongoing conflict in Iran. The surge was driven largely by energy costs, which accounted for 40% of the total rise, alongside significant increases in shelter and food prices. This data suggests that higher input costs from oil are being readily passed through to consumers, adding to concerns about the durability of the inflationary trend.
Consequently, the Federal Reserve is expected to maintain current interest rates through June and likely for most of 2026. Market pricing via the CME FedWatch tool reflects this cautious stance, indicating a nearly 98% probability that rates will remain steady at the next meeting. However, the outlook extends further, with the probability of a rate hike by December rising to nearly 30%. This shift signals that the central bank is preparing for a more complex economic environment than previously anticipated.
Fed officials warn that a sequence of compounding economic shocks may prevent inflation from returning to the 2% target. Governor Chris Waller and Cleveland Fed President Beth Hammack have highlighted that the current situation involves the pandemic's supply chain disruptions, the Russia-Ukraine invasion, recent tariff implementations, and now the Iran war. Officials caution that if these shocks hit one after another, they could keep inflation elevated for quite some time, making the standard practice of looking through temporary oil price surges problematic.
Core inflation, which excludes volatile food and energy prices, climbed to 2.8%, exceeding expectations of 2.7% and previous levels of 2.6%. Services inflation excluding energy increased by 3.3%, while goods prices rose by 1.1%, partly attributed to tariffs. This broadening of the inflation impact reinforces the reality that new Fed leadership will not result in an immediate dovish shift, challenging previous assumptions that artificial intelligence could help push down inflation.
The Federal Open Market Committee is now considering shifting its policy language from anticipating rate cuts to acknowledging two-sided risks, including the possibility of rate hikes. Incoming Fed Chair Kevin Warsh faces pressure to abandon previous dovish assumptions given the current data, as the increase in core CPI suggests high energy prices are making themselves felt throughout the economy. Economists note that while the Fed will not necessarily pivot to rate hikes immediately, the risk bias inside the statement is likely to change to set up for potential increases if inflation gets sticky and persistent.
