Jul-24 PCE inflation flat at 2.5%, as energy prices ease

2 Sep 2024 , 01:49 PM

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.

• Personal income in July 2024 increased by $75.1 Billion (0.3% monthly) as per the estimates put out by the US Bureau of Economic Analysis (BEA).
  
• Disposable personal income (DPI); which is personal income minus personal taxes, increased $54.8 Billion (0.3%) while personal consumption expenditures (PCE) increased by $103.8 Billion (0.5%). Compared to last month, the DPI is sharply higher.
  
• The increase in current-dollar personal income in June 2024 primarily reflected increases in compensation.
  
• Let us turn to the positive drivers of $103.8 Billion increase in current dollar personal consumption expenditure (PCE) for July 2024. There was an increase of $59.3 Billion in spending for services and an increase of $44.5 Billion spending for goods. The latter has shown a substantial spike in July 2024.
  
• Within services, the largest contributors to the spike were housing, and utilities (led by housing).
  
• Within goods, the leading contributor to the increase were spending on motor vehicles and parts as well as food and beverages.
  
• Personal savings were lower at $598.8 Billion in July 2024 and the ratio of personal savings to disposable personal income fell by another 50 bps to 2.9%.

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.

• Headline PCE inflation has shown a secular downward trend since April 2023. Between November 2023 and July 2024, the PCE inflation has fallen 10 bps to 2.5%.
  
• PCE inflation for goods in July 2024 was flat at 0.0% compared to -0.2% in the month of June 2024 and -0.1% in May 2024. Within goods, the durable goods showed further improvement from -2.9% to -2.5% while the inflation in non-durable goods bounced by 10 bps from 1.2% to 1.3%. However, this comes on the back of a 40 bps spike in non-durable goods inflation that we saw in June 2024.
  
• For July 2024, the services inflation tapered by another 10 bps from 3.8% to 3.7%. In the last 3 months, services inflation has steadily tapered by 10 bps each month. Incidentally, the services inflation is down a full 190 bps from a high of 5.6% in April 2023.
  
• Core PCE inflation yoy has shown a consistent downtrend from June 2023 till February 2024; falling 150 bps from 4.3% to 2.8%. in the last 3 months of May, June, and July 2024, the core PCE inflation has been static at 2.6%.
  
• On a yoy basis, July 2024 PCE food inflation was steady at 1.4% after the 20 bps spike in June. However, PCE food inflation is sharply down by 330 basis points from 4.7% in June 2023.
  
• Energy inflation continues to be the crux of the inflation problem in the US, largely on account of the Red Sea crisis keeping oil prices buoyant. Between January 2024 and May 2024, the PCE energy inflation has spiked from -4.9% to +4.8% (a spike of 970 bps). However, in June 2024, the energy inflation had eased by 280 bps to 2.0%; and it has further eased by another 10 bps to 1.9% in July 2024.

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.

• After being elevated in the range of 0.3% to 0.4% in the last 4 months, the MOM inflation fell back to 0.0% in May 2024. In June 2024, it had marginally bounced back to 0.1%, and has bounced by another 10 bps to 0.2% in July 2024.
  
• MOM PCE inflation for goods had bounced from -0.4% to -0.2% in June 2024; and has bounced another 20 bps to 0.0% in July 2024. The durable goods inflation fell sharply from 0.0% to -0.3%, while non-durables inflation rebounded from -0.3% to +0.1%. Services inflation MOM in July 2024 stayed static at 0.2% for third month in a row.
  
• High frequency Core PCE inflation in July 2024 was flat at 0.2%, while the food inflation (MOM) picked up from 0.1% to 0.2%. However, it looks like short term pressures on energy are back with MOM energy inflation bouncing from -2.1% to 0.0%.

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.

• The probability of the first rate cut happening in September 2024 is now 100%; in fact, there is a 30% chance of 50 bps rate cut in September.
  
• What about the situation at the end of 2024? By December 2024, there is a 100% probability of 3 rate cuts. There is also 70.0% probability of 4 rate cuts by December, and this could spike if Fed cuts rates by more than 25 bps in September 2024.
  
• What about calendar 2025? By June 2025, there is a 100% probability that there would be 5 rate cuts in all, while there is a strong 97.5% probability of 6 rate cuts happening by June 2025.
  
• Let us also look at the scenario by December 2025, the last month for which estimates are available. By December 2025, there is a 95.2% probability that there would be 7 rate cuts in all, while there is a strong 79% probability of 8 rate cuts happening by December 2025; or the equivalent of 200 bps from current levels.

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.