The Inflation Cushion Is Shrinking

• The average price for a gallon of gasoline rose 28% in April.

• Regional Fed prices received data showed an increase last month.

• The scenario could drive real rates even lower.

The headline inflation picture is about to get more complicated…

This week delivers a key update for investors tracking the Federal Reserve’s monetary policy outlook. The U.S. Bureau of Labor Statistics (“BLS”) will release its April Consumer Price Index (“CPI”) this morning. And if you’ve filled up your tank recently, you already know the setup: headline inflation is headed higher.

According to the Energy Information Administration (“EIA”), the average gallon of gasoline last month cost $4.24. That’s the highest level since mid-2022, when inflation was retreating from a four‑decade peak. It also marked a 28% jump from April 2025…  

As the chart above shows, the first quarter typically produces the fastest annualized price growth of the year. But this past month was nowhere near the usual 7% seasonal gain. The move pushed the Cleveland Fed’s staff to project headline CPI could reach 3.6%, a level we haven’t seen since late 2023. That shift has stoked Wall Street’s anxieties about whether rate hikes might re‑enter the conversation.

Chairman Jerome Powell has signaled the Fed is willing to give the Iran conflict more time before reacting. Policymakers are hoping the White House can resolve the situation quickly enough to prevent oil prices from staying elevated and feeding inflation. Based on the data I track, the recent jump in energy costs hasn’t yet filtered into broader goods and services prices. That gives the Fed leeway to remain patient, but its patience may be wearing thin.

But don’t take my word for it, let’s look at what the data’s telling us …

To get an idea of what inflation growth might look like each month, I built a gauge using monthly manufacturing and services index data from the Dallas, Kansas City, New York, and Philadelphia Fed districts. These surveys ask businesses whether activity is rising, falling, or holding steady, and then publish indexes to capture the change. Together, these regions represent roughly 32% of national economic output. I focus on the “prices received” components because they serve as a proxy for CPI.

Each district is weighted by its contribution to national growth, giving us a cleaner read on how they influence the overall picture. In April, the combined manufacturing prices‑received index came in at 31, up from 23.2 in March. That’s back to levels we experienced in early 2025 when price growth last hovered around 3%…  

Manufacturing, however, accounts for only about 10% of domestic output. Services matter far more. That sector includes healthcare, education, finance, hospitality — the parts of the economy where most Americans work and spend. My gauge shows the services index increased slightly from 17.1 in March to 20.5 in April, However, that’s still within the recent outcome range…

Next, I blended the two measures, weighting them by economic importance and their relevance to CPI. Because services dominate the U.S. economy, they carry more sway in the combined reading. The composite came in at 24.2 for April, compared to 19.3 in March. This is above the recent range, but not terrible…

This matters because it tells the Fed that companies are raising prices on consumers. They’re likely passing on the elevated fuel costs from the last couple of months. In fact, the details show Dallas, Kansas City, and Philadelphia all saw surges while the New York index was little changed. In addition, a surge in new orders could be supporting this decision. Policymakers still have cover to look past the gas‑price spike before making any interest rate moves, but their tolerance is likely wearing thin if prices keep surging.

So, the last step is to measure the Fed’s interest rate cushion. We can do this by looking at the real rate of interest (effective federal funds rate minus inflation). A positive number means policy is weighing on price growth, while a negative number means rates are stoking inflation. According to the most recent CPI figures, rate hikes aren’t necessary…

In March, the effective federal funds rate was roughly 3.6% while inflation stood at 3.3%. That means about 30 basis points of room before policy hits the so‑called neutral level, where rates neither help nor hinder growth. And since the Fed has managed the real rate to an average of –0.6% since 2000, it implies policymakers have a cushion of much as 90 basis points before reaching that long‑term norm.

Now let’s apply the Cleveland Fed’s 3.6% CPI estimate. Under that scenario, the current rate‑cut cushion shrinks to just 0%. But when we factor in the long‑term average, the potential rises to 0.6%.

Bottom line: the margin for rate cuts is disappearing. The Fed still has room to stay on hold but policymakers’ anxieties may be up. However, if the situation in the Middle East resolves sooner than later, the door to lower borrowing costs could reopen. That would free up cash, support economic growth, and help sustain a steady, long‑term rally in the S&P 500.

Five Stories Moving the Market:

U.S. President Donald Trump said the cease-fire between the U.S. and Iran is on “massive life support,” after he rejected Iran’s response to a proposal for ending the war as unserious; Trump called Iran’s counteroffer “a piece of garbage,” saying he didn’t even bother reading the entire document – Bloomberg. (Why you should care – Iran said a decision on its nuclear program would be left until the “time is right”, likely leaving negotiations at an impasse)

The Pentagon announced that a U.S. Navy nuclear-armed submarine has arrived in Gibraltar, a rare acknowledgement of the whereabouts of one of America’s most secretive weapons a day after President Trump forcefully rejected Iran’s latest peace offer – WSJ. (Why you should care – the Pentagon rarely discloses the location of these submarines, likely increasing tensions with Iran)

Kevin Warsh, U.S. President Donald Trump's pick to be the next chair of the Federal Reserve, cleared a key procedural hurdle in the Senate, ​moving him closer to Senate confirmation and a smooth handoff from Fed Chair Jerome ‌Powell – Reuters. (Why you should care – Warsh’s tenure is likely to see the central bank switch more of its balance sheet holdings to shorter-term bond holdings)

U.S. President Donald Trump said he will reduce the 18-cent federal gas tax for a yet to be determined period as U.S. fuel prices shoot higher ​due to the Iran war; waiving the tax requires Congress, currently controlled by Republicans, ​to pass legislation – Reuters. (Why you should care – Senate Democrats had proposed suspending the gas tax as recently as March, improving the chances of any legislation receiving the 60 votes required for passage in the chamber)

Japan’s household spending fell for a fourth consecutive month even as wages continued to grow; outlays by households adjusted for inflation declined 2.9% in March from a year earlier, according to the Ministry of Internal Affairs and Communications – Bloomberg. (Why you should care – money is increasingly being spent on needs like food, utilities, and clothing, and less on items like communications and transportation)

Economic Calendar:

Earnings: ARMK, CAMT, FNV, JD, OKLO, SE, VOD, ZBRA

Japan – Household Spending for March

BOJ – Summary of Opinions

Fed’s Williams (New York, Voter) Speaks (3:15 a.m.)

Germany – ZEW Economic Sentiment for May (5 a.m.)

U.S. – NFIB Small Business Optimism for April (6 a.m.)

U.S. – ADP Employment Change Weekly (8:15 a.m.)

U.S. – CPI for April (8:30 a.m.)

U.S. – Crude Oil Inventories (10:30 a.m.)

Treasury Auctions $80 Billion in 6-Week Bills (11:30 a.m.)

Treasury Auctions $50 Billion in 52-Week Bills (11:30 a.m.)

U.S. – EIA Short‑Term Energy Outlook (12 p.m.)

Treasury Auctions $69 Billion in 2-Year Notes (1 p.m.)

Fed’s Goolsbee (Chicago, Non‑Voter) Speaks (1 p.m.)

BoE’s Woods (Deputy Governor) Speaks (1:30 p.m.)

U.S. – Federal Budget Balance for April (2 p.m.)

U.S. - American Petroleum Institute Crude Oil Inventory Data (4:30 p.m.)