Morgan Stanley: U.S. April CPI cooling is just the beginning, inflation will accelerate and slow down in the second half of the year

The United States has long been plagued by high inflation, with stubborn service sector inflation being the "culprit". Morgan Stanley expects service inflation to accelerate its decline in the second half of this year, leading to a cooling of overall inflation.

Ahead of the release of the highly anticipated April CPI on Wednesday, Morgan Stanley called for a "cooling" in its report, forecasting a month-on-month core CPI of 0.29% and a year-on-year growth rate of 3.6%; the overall CPI is expected to have a month-on-month increase of 0.37% and a year-on-year growth rate of 3.4%, both slowing from previous values.

Morgan Stanley emphasizes that the core CPI inflation in April will fall, mainly due to weakening service sector inflation. It is expected that auto insurance inflation will weaken, rental deflation will continue, healthcare prices will decrease, and it points out that service inflation will accelerate its decline in the second half of the year.

Looking ahead, Morgan Stanley predicts that from a synchronized growth perspective, the core CPI will drop below 3% by early 2025; month-on-month forecasts indicate that inflation will gradually weaken in 2024 and stabilize. The forecast by Morgan Stanley reflects a more pronounced slowdown in inflation in the second half of 2024.

Therefore, Morgan Stanley remains optimistic about the prospect of the Federal Reserve cutting interest rates three times this year, with the first rate cut postponed from July to September, followed by two more cuts in November and December. As inflation continues to move towards the 2% target, four more rate cuts are expected by mid-2025, and the federal funds rate target range will reach 3.625%.

Accelerated slowdown in service inflation in the second half of the year

Morgan Stanley points out that cooling in the labor market and weak new leasing data indicate a further slowdown in rental inflation, with its model showing that faster rental inflation deceleration may come in the second half of 2024.

The softness in new leasing rents in the fourth quarter of 2023 and the first quarter of 2024 is consistent with our view that rents should slow more rapidly in the second half of 2024. NTRR typically leads rental CPI by 3 quarters.

The next few months will be crucial for rental inflation, as some market participants expect rents to plummet as they did on March 23. Given the relative stability of typical predictors of rental inflation, rental inflation is expected to steadily decelerate.

At the same time, Morgan Stanley also sees softer trends in auto insurance and healthcare service prices:

Although the previous period saw auto insurance inflation exceeding expectations, the report expects this trend not to continue. The improvement in the profitability of the auto insurance industry will prompt insurance companies to shift towards growth-oriented strategies, slow down the pace of price updates, expand to more states, and intensify competitionThis means that future car insurance inflation will decrease, with a slowdown expected to begin in the second half of 2024.

In terms of medical service prices, driven by the decrease in medical insurance prices, the growth of the healthcare industry will slightly slow down. Health insurance has a considerable lag, and the CPI for health insurance in April will be updated to include data from the first half of 2023, with an average health insurance inflation rate of 0% expected from April to September.