May 2023 US inflation falls to 4%, paving the way for Fed pause

14 Jun 2023 , 06:13 AM

May 2023 saw US consumer inflation at 4% for the first time since March 2021. In March 2023, inflation had fallen 100 bps but it fell just 10 bps to 4.90% in April. In May 2023, inflation has fallen another 90 bps to 4.0%. It is 27 months since the US saw sub-4% inflation, so it will give a lot of comfort to the US Federal Reserve. As of May 2023, consumer inflation in the US has fallen 510 basis points from the peak of 9.1% in June 2022. To add to the positive news flow, even the MOM inflation in May 2023 is down to just 0.1%, underlining the fact that even the high frequency triggers are pointing downwards. What does it mean for Fed rate action?

In the minutes of the May 2023 policy, the Fed had made a strong case for a pause in June. In fact, Jerome Powell also mentioned that a pause in rates in June was called for after the relentless hawkishness since March 2022. The Fed has already raised rates by 500 basis points since March 2022 and now inflation has fallen by a full 500 bps from the peak levels of April 2022. With consumer inflation falling so sharply to 4%, there is a strong case for the Fed to pause on rates in the June policy, which will be announced on June 14, 2023, just a day after the inflation data. However, Fed is also likely to clarify that rate hikes were not done since their inflation target of 2% is still some time away.

Fall in US consumer inflation has been progressive

The fall in US inflation from the peak in June 2022 has been 510 bps in response to a 500 bps spike in interest rates. That almost appears proportional. However, the glide path has been more encouraging since yoy inflation each month has fallen progressively instead of showing sudden spikes. It may be recollected that US consumer inflation had peaked at 9.1% in June 2022. Since then, it has reduced progressively to 8.5%, 8.4%, 8.2%, 7.7%, 7.1%, 6.5%, 6.4%, 6.0%, 5.0% and 4.9% between July 2022 and April 2023. The month of May 2023 saw a sharp and decisive fall in consumer inflation to 4.0%. The last time US consumer inflation was under 4% was in March 2021. If one looks at the break-up of consumer inflation in May 2023, food inflation is sharply lower by 100 bps, energy inflation is deeper into negative while core inflation dipped by a marginal 10 bps only.

Energy inflation which had dipped to negative in March 2023, continues to remain in negative, and it just got deeper in May 2023. In the energy basket, energy products are sharply into negative while energy services have bounced back. Interestingly, the prices of piped gas supply fell sharply in the US. This broadly syncs with the message given by the Fed over the last couple of meetings that the problem of inflation in the US was far from over, at least core inflation continues to remain above 5%. Even at 4.0%, the US consumer inflation of May 2023 remains about 200 bps higher than the 2% inflation target that the Fed is looking at. The bigger challenge would be to guide inflation lower, without hitting growth, and that is what the Fed would be worried about.

Food and energy taper; but core inflation remains sticky

Even as the impact of the 500 bps Fed rate hike is manifesting in the form of 510 bps fall in inflation, Fed has hinted at more rate hikes, if necessary. However, for now, indications are that the Fed will pause in June and then take a fresh view after that.

Inflation Basket Category	May 2023 (YOY)	Apr 2023 (YOY)	Inflation Basket Category	May 2023 (YOY)	Apr 2023 (YOY)
Food Inflation	6.70%	7.70%	Core Inflation	5.30%	5.50%
Food at home	5.80%	7.10%	Commodities less food and energy	2.00%	2.00%
Cereals and bakery products	10.70%	12.40%	Apparel	3.50%	3.60%
Meats, poultry, fish, and eggs	0.30%	2.80%	New vehicles	4.70%	5.40%
Dairy and related products	4.60%	8.00%	Used cars and trucks	-4.20%	-6.60%
Fruits and vegetables	2.70%	2.00%	Medical care commodities	4.40%	4.00%
Non-alcoholic beverages	8.70%	9.50%	Alcoholic beverages	4.80%	4.60%
Other food at home	9.20%	10.40%	Tobacco and smoking products	6.30%	6.60%
Food away from home	8.30%	8.60%	Services less energy services	6.60%	6.80%
Full service meals and snacks	6.80%	7.20%	Shelter	8.00%	8.10%
Limited service meals	8.00%	8.20%	Rent of primary residence	8.70%	8.80%
Energy Inflation	-11.70%	-5.10%	Owners’ equivalent rent	8.00%	8.10%
Energy commodities	-20.40%	-12.60%	Medical Care Services	-0.10%	0.40%
Fuel oil	-37.00%	-20.20%	Physician Services	-0.10%	0.30%
Gasoline (all types)	-19.7%	-12.20%	Hospital Services	3.70%	2.90%
Energy services	1.60%	-5.90%	Transport Services	10.20%	11.00%
Electricity	5.90%	8.40%	Motor vehicle Maintenance	13.50%	13.30%
Natural gas (piped)	-11.00%	-2.10%	Motor vehicle insurance	17.10%	15.50%
Headline Consumer Inflation	4.00%	4.90%	Airline Fare	-13.40%	-0.90%

Data Source: US Bureau of Labour Statistics

Here are some takeaways.  Firstly, food inflation has fallen across the board on a yoy basis, especially in the high protein products like milk, eggs, and dairy. Under energy category, energy products have dipped deeper into negative while energy services have bounced back. The concern could be on core inflation. It has been inching lower and in May 2023 it has inched lower by another 10 bps, keeping headline inflation sticky.

MOM inflation falls sharply to 0.1% in May 2023

The US Bureau of Labour Statistics (BLS) reports inflation on yoy basis, as well as on MOM high frequency basis. After touching a high of 1.2% in June, MOM inflation stayed below 1% all through. However, after a spike in January and February to 0.5% and 0.4% respectively, MOM inflation cooled to 0.1% in March 2023. In April, it is back at 0.4%, but May 2023 again saw MOM inflation softening back to 0.1%.

Here are key takeaways from the MOM inflation data for May 2023.

1. MOM food inflation rose 0.2% compared to April 2023. In fact, 3 out of the 6 store food categories saw higher inflation viz. fruits, food at home and non-alcoholic beverages.

    

2. Energy index fell -3.6% MOM in May 2023 as gasoline prices fell 5.6%. Downward pressure is seen in commodities while energy services are holding up.

    

3. Core inflation again rose 0.4% MOM in May 2023; like in March and April.  The pressure comes from the shelter index rising 0.6% and index for rent rising by 0.5% in May 2023.

This looks like good news for the RBI

Why would a fall in the US inflation be good news for the RBI? Let us first understand the Fed stance. In the May policy minutes it was clear that the dissensions were widening internally and the only option would be to pause on rates in June. With the Fed policy coming just a day after the inflation reading, a pause in rates looks very likely. Why would that be positive for the RBI.

When the RBI decided to pause in April, it was a brave decision since central banks in the developed world were still hawkish. The US Fed has hiked rates by 50 bps after that. That creates a problem of monetary divergence which not only disrupts the portfolios flows but also makes the bond markets and the currency markets very volatile. If the US is taking a likely pause in June, that obviates the risk for the RBI and for the Indian economy.

For the RBI, there is a greater level of comfort from the fact that inflation is just 25 bps away from the 4% target while for the US Fed, inflation is still 200 bps away from its 2% target. The FPI flows of $5.3 billion in May 2023 is affirmation that FPIs have applauded the RBI decision to hold rates. If the US Fed takes a pause, it also does away with the risk of monetary divergence. That should surely suit the RBI.