Hello, my name is Stephanie Aliaga and I am a research analyst at J.P. Morgan Asset Management, with an update on the recent inflation report and our latest thinking on the outlook for the economy.

The April CPI report showed a bounce in inflation due to higher gas prices and the lagged impact of higher used car auction prices, offsetting declines in other areas. However, gas prices have come down in May and the Manheim used car index also fell, which tells me those upside drivers have already come and gone. Softness in services inflation, particularly in lodging and airlines fares, also bodes well for continue moderation in core inflation. Looking forward, we may well see annual headline CPI drop to 3.5% or lower by June, as core goods and services ex-shelter prices continue to slide.

Overall, we don’t think this report changes the Federal Reserve’s plans to pause after its latest rate hike to a range of 5.00-5.25%, with futures markets only pricing in a 9% chance of a June hike. At this point, I think the Fed’s reaction function to each incremental inflation report has softened, and we would need to see a sustained revival in inflation to get them going again. Instead, the Fed is going to keep a close eye on impact of tightening lending standards, which has the potential to tip us into recession.

To that end, earlier this week, we saw the Fed’s latest Senior Loan Officer Survey, which showed that bank lending standards tightened slightly but not nearly as much as feared in the wake of the regional banking crisis. Although the demand for loans has dropped sharply. Other survey measures have shown that credit is getting hard to find, particularly for small businesses, and for those companies that can access credit, the cost of that funding is much higher now due to the Fed’s rate hikes.

This will continue to weigh on capital spending plans and entice businesses to be more conservative in their hiring plans, taking job listings off the board or lowering wage increases for new and existing employees. These pressures will build gradually, but it brings the likelihood that the economy enters recession by the end of the year to at least 60%, if not more.

So while the inflation deceleration is a good thing, extreme monetary tightening is still in place and is slowly dragging on the economic outlook, increasing the potential for the Fed to be forced cut rates by the end of the year, despite their continued pushback against the notion.

Well thank you for listening. For more of our insights on inflation, the economy and investing you can check out our website at jpmorganfunds.com/insights or our mobile app “Insights” by J.P. Morgan Asset Management.

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