The 'supercore' inflation measure suggests the Fed may face a significant challenge.

• The supercore inflation reading is generating excitement in markets as a more precise measure of prices.
• The gauge, which tracks services inflation excluding food, energy, and housing, has surged recently, with a 4.8% year-over-year increase in March and a 3-month annualized pace of more than 8%.
• Household necessities such as car and housing insurance, as well as property taxes, contribute to the complexity of services inflation.

The unexpectedly high consumer price index reading caused markets to be shaken on Wednesday, but there is excitement among investors about a more detailed inflation measure within the data - the supercore inflation reading.

In addition to the overall inflation rate, economists examine the core CPI, which removes fluctuating food and energy prices, to determine the accurate trend. The supercore index, which also excludes housing costs from its services reading, provides a more comprehensive view. According to Fed officials, it is particularly useful in the current environment as they view the current housing inflation as a short-term issue and not a reliable indicator of long-term price trends.

In March, Supercore's year-over-year growth rate accelerated to 4.8%, which was the highest in the past 11 months.

According to Tom Fitzpatrick, managing director of global market insights at R.J. O'Brien & Associates, if you calculate the average inflation rate over the past three months and extrapolate it for the entire year, it exceeds 8%, which is significantly higher than the Federal Reserve's target of 2%.

"I believe they're likely pulling their hair out as we sit here today," Fitzpatrick remarked.

An ongoing problem

Last month, the Consumer Price Index (CPI) increased by 3.5% year-over-year, surpassing the Dow Jones estimate of 3.4%. This data put pressure on equities and caused Treasury yields to rise on Wednesday. As a result, futures market traders extended their expectations for the central bank's first rate cut from June to September, according to the CME Group's FedWatch tool.

Stephen Stanley, chief economist at Santander U.S., stated that while they may not truly care about the specifics as long as they reach 2%, the truth is that achieving a sustained 2% is unlikely without a significant reduction in cooling services prices. At present, this reduction is not visible.

Since the beginning of the year, Wall Street has closely monitored the trend of supercore inflation. A rise in the metric from the January CPI print was sufficient to undermine the market's belief that the Fed was successfully combating inflation, as stated by Ian Lyngen, head of U.S. rates strategy at BMO Capital Markets.

The Fed faces another issue, according to Fitzpatrick, which is the contrasting economic environment of high inflation and strong stimulus payments that boosted consumer spending in 2021 and 2022, leading to record inflation levels.

Household necessities such as car and housing insurance, as well as property taxes, have made the picture more complicated today, according to him.

"Fitzpatrick stated that the fear of what occurred in 2021 and 2022 has caused them to be in a difficult position, as the spending items are not discretionary and they are caught between two options."

Sticky inflation problem

Fitzpatrick stated that the central bank is likely to maintain a restrictive monetary policy due to a declining consumer savings rate and rising borrowing costs, and will continue to do so until something changes.

The recent upward moves in inflation are more closely analogous to tax increases, and the Fed will have a hard time bringing down inflation with more rate hikes because the current drivers are stickier and not as sensitive to tighter monetary policy, Fitzpatrick cautioned.

As long as inflation remains above their 2% target, the possibility of the Fed hiking interest rates further remains.

"Stanley stated that he believes inflation will decrease and rates will be cut later than expected. However, he questioned whether this trend has become ingrained and if the possibility of rate hikes will reemerge at some point."