US INFLATION NEEDS TRIGGERS; BUT WHERE ARE THE TRIGGERS?
Like we deciphered from the Fed statement, the FOMC minutes of the June Fed meeting, published on July 03, 2024 also betrayed a high level of inflation fear. The FOMC members have admitted that disinflation was happening, GDP growth had slowed and that the labour market was in a better balance. However, there was no hint about the timing of the first rate cut. Clearly, the monetary caution of the Fed does not appear to be supported by the recent data flows either on the inflation front or on the growth front. Let us first look at inflation. The PCE inflation (the Fed benchmark) has come in lower at 2.6%. The PCE inflation, based on personal consumption expenditure, has not only tapered but the driver for lower inflation has been pressure on consumption spending. Food and core inflation are consistently coming down, with energy inflation being the sole major concern.
That is the issue. The Fed appears to be worried about inflation at a time when there are few genuine triggers for inflation. Let us look at some of them. Firstly, the GDP growth has sharply slowed in the first quarter to just 1.4% compared to 4.9% and 3.3% in the third and fourth quarters of 2023, respectively. The small growth is also on the back of corporate investing with consumer spending under pressure. Secondly, the labour market is substantially in balance, with the unemployment in the range of 4.0% to 4.1%. Wages have also stabilized, so the fear of labour tightness leading to higher wages and supporting consumption is not valid any longer. Above all, if you break up the inflation; you find that food and core inflation are consistently down. The only risk is coming from energy inflation, which is more cyclical in nature. Being the largest producer of oil in the world, higher energy prices should matter less to the US consumers. That is why, it is looking like the Fed is worried about inflation; when there are not enough triggers for inflation.
CIRCA FED MINUTES (JULY 2024) – OUR 6 KEY READINGS
The minutes of the June Fed meeting were published by the FOMC on July 03, 2024. Here are our 6 key readings from the FOMC minutes and its implications for the future trajectory of interest rates.
To sum up, the mood in the FOMC camp has shifted from one of scepticism to one of cautious. That is an improvement. However, there is still a long mental road to traverse, before the Fed embarks on rate cuts. The question is not whether; but when!
FED MINUTES AND THE IMPACT ON CME FEDWATCH
The table below captures the rate cut probabilities over the next 10 Fed meetings, based on the implied probabilities in the Fed futures trading; post the Fed minutes publication.
Fed Meet | 300-325 | 325-350 | 350-375 | 375-400 | 400-425 | 425-450 | 450-475 | 475-500 | 500-525 | 525-550 |
Jul-24 | Nil | Nil | Nil | Nil | Nil | Nil | Nil | Nil | 8.8% | 91.2% |
Sep-24 | Nil | Nil | Nil | Nil | Nil | Nil | Nil | 6.2% | 67.3% | 26.5% |
Nov-24 | Nil | Nil | Nil | Nil | Nil | Nil | 2.2% | 27.9% | 52.8% | 17.1% |
Dec-24 | Nil | Nil | Nil | Nil | Nil | 1.6% | 21.3% | 46.4% | 26.3% | 4.4% |
Jan-25 | Nil | Nil | Nil | Nil | 0.9% | 12.5% | 35.2% | 35.3% | 14.2% | 2.0% |
Mar-25 | Nil | Nil | Nil | 0.6% | 8.2% | 26.7% | 35.2% | 22.1% | 6.5% | 0.7% |
Apr-25 | Nil | Nil | 0.2% | 3.7% | 15.8% | 30.2% | 29.8% | 15.6% | 4.1% | 0.4% |
Jun-25 | Nil | 0.1% | 2.3% | 10.9% | 24.4% | 30.0% | 21.3% | 8.8% | 1.9% | 0.2% |
Jul-25 | 0.1% | 0.9% | 5.5% | 15.8% | 26.4% | 26.8% | 16.8% | 6.3% | 1.3% | 0.1% |
Sep-25 | 0.7% | 4.4% | 13.5% | 24.0% | 26.7% | 19.1% | 8.7% | 2.4% | 0.4% | Nil |
Data source: CME Fedwatch
Not much has changed in the probabilities post the FOMC minutes. The market is still betting on the first rate cut happening in September 2024. Here is a quick view of the probabilities on a granular basis.
The moral of the story is that the markets are expecting aggressive rate cuts. Even if the Fed chooses to go slow in 2024, it is likely to compensate for that with greater aggression in 2025. That is what the post-FOMC minutes Fedwatch is indicating.
READING BETWEEN THE LINES OF THE JULY 2024 FED MINUTES
The FOMC minutes of the June meeting, published on July 03, 2024, has a clear cautious bias; but not a sceptical tilt. The markets are of the view that even if the Fed goes slow in 2024, it will compensate for that in 2025. Here is what we interpreted from the FOMC minutes published on July 03, 2024.
The mood was best summed by none other than the Fed chair, Jerome Powell, in one of his speeches delivered at Portugal. “ The risks of cutting too soon and risking a resurgence in inflation against cutting too late and endangering economic growth have come more into balance.” The downside risks to Fed decisions, from here, are fairly low.
HOW WILL RBI INTERPRET THE FED JUL-24 MINUTES?
It may be recollected that the RBI had implemented its last rate hike in February 2023 and has since held rates static for the next 8 meetings; including the June 2024 MPC (Monetary Policy Committee) meeting. For the last few months, the status quo was justified on the grounds that elections were on and the government needed to present the full budget. Now, a new government is already in place (Modi 3.0) and the full budget is being presented in the last week of July. While India has been grappling with erratic food inflation, the headline inflation has been consistently under 5% for 3 months in a row. Even if the RBI may not turn entirely dovish in its view, there is a strong possibility that the RBI may undertake a pre-emptive rate cut in its August MPC meeting. Also, high interest rates and high cost of funds are already posing a big challenge for corporate numbers in this quarter.
Having said that, it is not clear if the RBI would cut rates in August before the US Fed changes tack. However, the RBI was ahead of the Fed in calling a peak on rates in February 2023. The question is, how much worse could the oil price situation get from here? The Red Sea crisis is still festering and now Russia has announced supply cuts later this year. That is already putting pressure on oil prices and that can be a source of imported inflation for the Indian economy. If the full budget makes bold reforms, then the RBI will have the incentive to support the fiscal boost with monetary boost. We may get the first signals of a rate cut by the RBI only from the Union Budget undertone!
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