A DAY GDP UPGRADE; PCE INFLATION COMES IN FLAT
The much awaited PCE inflation for July 2024 came in flat at 2.5%. This is the same level as the previous month. In the last 9 months, the PCE Core inflation has averaged 2.8%, while the PCE Headline Inflation has averaged 2.58%. That should give a lot of comfort to the Fed, since the PCE inflation shows clear signs of stabilizing. One can still worry about the last mile journey of PCE inflation to 2%, but that should eventually happen. At least, for the highly anticipated 25 bps rate cut by the Fed in September 2025, inflation should not be a concern any longer. For the US Federal Reserve, the trend in PCE inflation guiding factor; whether the Fed should cut rates or not. The average PCE inflation over the last 8 months is clearly hinting that the time is ripe for rate cuts. But, we will come back to this point later. The narrow range of PCE inflation in 2024 is a clear sign that the worst may be over. Fortunately, for the Federal Reserve, even the consumer inflation appears to be falling in tandem.
However, the picture becomes more eloquent if one looks at the PCE inflation in tandem with the second estimate of the Q2 GDP that was announced on the previous day. It may be recollected that; the first advance estimate of Q2-2024 US GDP had bounced to 2.8% from a low of 1.4% in Q1-2024. Now the second estimate of Q2-2024 GDP had been further upgraded by 20 bps to 3.0%. One interpretation could be that the GDP is already robust, so rate cuts are not required. The other line of interpretation could be that the hard landing has been avoided, so it is time to normalize interest rates to lower levels and make the best of this golden opportunity. The Fed is likely to plump for the second interpretation when it meets for the next meeting of the FOMC on September 18, 2024. The CME Fedwatch is already ultra-dovish while the Fed is still too cautious. The truth may like in between!
CORE INFLATION FLAT; BUT ENERGY INFLATION EASES IN JULY
In the last 1 year, the big story has been the core PCE inflation (ex-energy & food) leading the headline inflation lower in the US. That is not surprising as the supply chain constraints created by the pandemic had progressively eased. That story appears to have played out. In the last few months, headline inflation had been pushed lower by energy inflation as the risks in the Middle East and West Asia have not played out to the extend apprehended.
Month |
Headline PCE Inflation |
Core PCE Inflation |
November 2023 |
2.7% |
3.2% |
December 2023 |
2.6% |
2.9% |
January 2024 |
2.4% |
2.9% |
February 2024 |
2.5% |
2.8% |
March 2024 |
2.7% |
2.8% |
April 2024 |
2.7% |
2.8% |
May 2024 |
2.6% |
2.6% |
June 2024 |
2.5% |
2.6% |
July 2024 |
2.5% |
2.6% |
Data Source: US Bureau of Economic Analysis (US)
If you look at the data on PCE inflation and core PCE inflation over the last 9 months; both are decisively lower. The trend in recent months has been that, while core inflation and food inflation have been in a narrow range, easing energy inflation has helped the headline PCE inflation to normalize. Between November 2023 and July 2024; the headline PCE inflation has eased by 20 bps while the core PCE inflation eased by 60 bps. If energy is supportive in the coming months, then the journey to 2% PCE inflation should be a lot simpler.
PERSONAL INCOME NARRATIVE FOR JULY 2024?
PCE inflation is relevant in 2 ways. Unlike the consumer inflation announced in the middle of the month, the PCE inflation comes at the end of the month; thus, allowing more data points to be factored in. Secondly, PCE inflation reflects prices from a personal consumption expenditure (PCE) perspective. That is why the US Fed relies more on PCE inflation as the benchmark for rate action. Here are key July 2024 data points.
The broad message is that persistent high inflation has taken its toll on personal savings and that is something that is likely to drive the decision on rate cuts going ahead.
BREAK-UP OF US PCE INFLATION (YOY) FOR JULY 2024
The US Bureau of Economic Analysis (BEA) publishes the PCE inflation on a yoy basis and on MOM basis. Let us first look at the PCE inflation on a yoy basis with granular break-up.
Break-up of PCE Inflation (YOY) |
Dec-23 |
Jan-24 |
Feb-24 |
Mar-24 |
Apr-24 |
May-24 |
Jun-24 |
Jul-24 |
Headline PCE Inflation (Year on Year) |
2.6 |
2.5 |
2.5 |
2.7 |
2.7 |
2.6 |
2.5 |
2.5 |
Goods |
0.2 |
-0.5 |
-0.2 |
0.1 |
0.1 |
-0.1 |
-0.2 |
0.0 |
Durable goods |
-2.3 |
-2.4 |
-2.0 |
-1.9 |
-2.2 |
-3.2 |
-2.9 |
-2.5 |
Nondurable goods |
1.6 |
0.5 |
0.8 |
1.3 |
1.4 |
1.6 |
1.2 |
1.3 |
Services |
3.9 |
4.0 |
3.9 |
4.0 |
4.0 |
3.9 |
3.8 |
3.7 |
Addenda: | ||||||||
Core PCE excluding food and energy |
2.9 |
2.9 |
2.8 |
2.8 |
2.8 |
2.6 |
2.6 |
2.6 |
Food |
1.4 |
1.4 |
1.3 |
1.5 |
1.3 |
1.2 |
1.4 |
1.4 |
Energy goods and services |
-1.7 |
-4.9 |
-2.3 |
2.6 |
3.0 |
4.8 |
2.0 |
1.9 |
Data Source: US Bureau of Economic Analysis (BEA)
The above table classifies yoy PCE inflation into goods and services inflation; and also breaks up inflation into food, energy, and core inflation. Here are major takeaways.
To summarize, the future trajectory of PCE inflation would largely predicate on energy inflation dynamics; as the other components have largely stabilized.
BREAK-UP OF US PCE INFLATION (MOM) FOR JULY 2024
The table below captures the high frequency month-on-month (MOM) inflation published by the US Bureau of Economic Analysis (BEA), capturing short term trends.
Break-up of PCE Inflation (MOM) |
Dec-23 |
Jan-24 |
Feb-24 |
Mar-24 |
Apr-24 |
May-24 |
Jun-24 |
Jul-24 |
Headline PCE Inflation (MOM) |
0.1 |
0.4 |
0.3 |
0.3 |
0.3 |
0.0 |
0.1 |
0.2 |
Goods |
-0.2 |
-0.2 |
0.5 |
0.1 |
0.2 |
-0.4 |
-0.2 |
0.0 |
Durable goods |
-0.5 |
0.2 |
0.2 |
0.1 |
-0.2 |
-0.8 |
0.0 |
-0.3 |
Nondurable goods |
-0.1 |
-0.4 |
0.7 |
0.2 |
0.5 |
-0.2 |
-0.3 |
0.1 |
Services |
0.3 |
0.7 |
0.2 |
0.4 |
0.3 |
0.2 |
0.2 |
0.2 |
Addenda: | ||||||||
Core PCE ex-(food and energy) |
0.2 |
0.5 |
0.3 |
0.3 |
0.3 |
0.1 |
0.2 |
0.2 |
Food |
0.0 |
0.5 |
0.1 |
0.0 |
-0.2 |
0.1 |
0.1 |
0.2 |
Energy goods and services |
-0.3 |
-1.4 |
2.3 |
1.2 |
1.2 |
-2.1 |
-2.1 |
0.0 |
Data Source: US Bureau of Economic Analysis (BEA)
Like the YOY inflation, even the MOM PCE inflation data is classified into goods and services inflation as well as food, fuel, and core inflation. Here are key takeaways.
More than sober MOM inflation, Fed will take solace from the fact that PCE inflation has been in a range in calendar year 2024; which gives it the much needed assurance.
DOES FED SHARE THE OPTIMISM OF CME FEDWATCH?
The CME Fedwatch has been increasingly getting optimistic about aggressive rate cuts by the Fed, but it remains to be seen if the Fed also shares that kind of enthusiasm. Here is a look at the CME Fedwatch probabilities after PCE inflation for July 2024 was announced.
Fed Meet |
250-275 |
275-300 |
300-325 |
325-350 |
350-375 |
375-400 |
400-425 |
425-450 |
450-475 |
475-500 |
500-525 |
Sep-24 |
Nil |
Nil |
Nil |
Nil |
Nil |
Nil |
Nil |
Nil |
Nil |
30.0% |
70.0% |
Nov-24 |
Nil |
Nil |
Nil |
Nil |
Nil |
Nil |
Nil |
8.9% |
41.8% |
49.3% |
Nil |
Dec-24 |
Nil |
Nil |
Nil |
Nil |
Nil |
3.5% |
21.8% |
44.8% |
30.0% |
Nil |
Nil |
Jan-25 |
Nil |
Nil |
Nil |
0.4% |
5.5% |
24.4% |
43.1% |
26.6% |
Nil |
Nil |
Nil |
Mar-25 |
Nil |
Nil |
0.9% |
7.4% |
26.2% |
41.5% |
23.9% |
Nil |
Nil |
Nil |
Nil |
May-25 |
Nil |
0.6% |
5.5% |
20.6% |
36.9% |
29.1% |
7.1% |
Nil |
Nil |
Nil |
Nil |
Jun-25 |
0.4% |
3.8% |
15.2% |
31.1% |
31.9% |
15.0% |
2.5% |
Nil |
Nil |
Nil |
Nil |
Jul-25 |
2.1% |
8.7% |
22.1% |
31.5% |
24.6% |
9.6% |
1.4% |
Nil |
Nil |
Nil |
Nil |
Sep-25 |
5.1% |
13.4% |
25.4% |
29.1% |
19.4% |
6.8% |
0.9% |
Nil |
Nil |
Nil |
Nil |
Oct-25 |
8.2% |
16.2% |
26.2% |
26.8% |
16.4% |
5.4% |
0.7% |
Nil |
Nil |
Nil |
Nil |
Dec-25 |
12.1% |
18.6% |
26.4% |
24.4% |
16.8% |
4.3% |
0.6% |
Nil |
Nil |
Nil |
Nil |
Data source: CME Fedwatch
The Fed Futures market has been enthusiastic about rate cuts for quite some time now, and the latest GDP and PCE inflation data have made the first rate cut a fait accompli in September 2024. Here is what we read from the above data.
While reading and interpreting the CME Fedwatch data, one must keep in mind that in the past, CME Fedwatch has got its aggression awfully wrong. The first signs of affirmation will only be there when the Fed takes up the first round of rate cuts in this cycle in September 2024. That is when a lot of these probabilities will assume more realistic values. The Fed, as the monetary system regulatory, would not want to compromise on price stability and inflation expectations. With sufficient hawks in the FOMC, they are most likely to err on the side of caution. The rate cuts are unlikely to be anything as optimistic or aggressive as the CME Fedwatch is suggesting.
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