As Americans’ expectations for near-term inflation surge once more, we are entering a critical era for financial markets and forecasters. Expectations for longer-term interest rates and rate cuts by the Federal Reserve will be influenced by upcoming reports on the Producer Price Index (PPI) and Consumer Price Index (CPI) for April, as well as fresh information on retail sales and industrial production. These reports will offer important insights into the real GDP growth and consumer spending in the second quarter.

A fundamental topic the new data will answer is whether current economic activity constitutes true expansion or is largely an inflationary fiction. The difference between the Atlanta Fed’s and the New York Fed’s current GDP projections reflects uncertainty regarding the health of the economy. The GDPNow estimate for Q2 from the Atlanta Fed has increased to 4.18% annualized, while the Nowcast from the New York Fed has dropped to 2.23%. Both figures are higher than the majority of economists’ growth projections, which are predicated on future declines in consumer spending and labor market expansion.

Rapidly growing consumer prices are cutting into spending power, with recent large price hikes in retail gasoline and other goods anticipating another high monthly inflation estimate. Significant gains in the prices-paid ISM Manufacturing and ISM Services indexes in April suggested that inflationary pressures had resumed. Furthermore, from 3.2% in April and 2.9% in March, consumer estimates for one-year inflation increased to 3.5% in May, according to the University of Michigan Consumer Sentiment Survey, which may be a warning sign.

Markets will be watching the CPI data for April, which is predicted to show a 0.4% increase in the headline measure for the third straight month and a modest slowdown in the core measure to 0.3%. It is anticipated that year-over-year headline and core inflation rates will moderate to 3.4% and 3.6%, respectively, mostly as a result of positive base effects rather than actual near-term inflation progress. Consequently, the FOMC’s belief that inflation is still too high is unlikely to be altered by a “hot” April CPI report. “Inflation remains too high, and the path to bringing it down is not assured,” according to remarks made by Fed Chair Jay Powell. Therefore, while strong consumer inflation is unlikely to trigger another rate hike, it will likely put the Fed on a cautious, data-dependent path over the summer and fall.

When retail sales for April are announced together with the CPI report, it is anticipated that there will be little rise in comparison to growing prices. Expected growth in advance retail sales is 0.4%, which is in line with the rate of inflation. However, growth falls to 0.1% when auto and gas purchases are excluded. It’s possible that retail sales, excluding gas and autos, may fall by 0.3% when adjusted for inflation. The current restrictive lending rates make vigorous consumer spending look increasingly unsustainable, especially given the rising auto and credit card delinquency rates, declining consumer confidence, and personal savings rates that are currently well below pre-pandemic levels at 3.2%.

In conclusion, the economic situation for the second quarter of this year is probably going to be characterized by real GDP and consumer demand slowing to a more manageable pace while inflation is still there. This is based on this week’s reports. Notwithstanding the continued uncertainty surrounding the near-term inflation outlook, this scenario may permit possible rate reduction from the Fed later in the year, maybe by September.