June 2023 US inflation falls to 3%, as persistent hawkishness pays off

14 Jul 2023 , 09:38 AM

In the last two months between April 2023 and June 2023, the yoy consumer inflation in the US has fallen a full 190 basis points from 4.90% to 3.00%. it is 28 months since the US saw sub-4% inflation, so it will give a lot of comfort to the US Federal Reserve to see the consumer inflation at just 3% and about 100 bps away from the Fed’s eventual target of 2%. As of June 2023, consumer inflation in the US has fallen 610 basis points from the peak of 9.1% in June 2022. However, it must be said that short pressures are still evident with the MOM inflation in June 2023 bouncing from 0.1% to 0.2%. How does this latest data point influence the Fed action going ahead?

It must be recollected that the Fed had already paused on its rate hike journey in June. The question is whether the sharp fall in inflation would induce the Fed to pause in the July 26, 2023 policy too. Even when the Fed had paused, the members had underlined the reality of 2 to 3 more rate hikes. Also, with the primary focus of the Fed still on bringing inflation to the 2% mark, the Fed may hike rates again by 25 bps in July. However, the Fed has already raised rates by 500 basis points since March 2022 and now inflation has fallen by a full 610 bps from the peak levels of June 2022. In the latest minutes of the Fed, several members had suggested not to front-end rate hikes now due to the positive impact on inflation. It may be a very mixed debate in the July policy, although the CME Fedwatch still favours a 25 bps rate hike in the July 2026 policy very strongly. 

US consumer inflation has fallen in a calibrated fashion

The overall fall in US inflation from the peak in June 2022 has been 610 bps in response to a 500 bps spike in interest rates. That looks like a good deal for the Fed and also a good reason for the Fed members to prevail on another pause. After all, when the lag effect is doing the job, why to stretch the macro limits? However, what is of special note in the US has been the glide path. The yoy inflation has fallen progressively instead of showing sudden spikes and any erratic movement. 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%, 4.9% and 4.0% between July 2022 and May 2023. The month of June 2023 saw another sharp and decisive fall in consumer inflation to 4.0%. If one looks at the break-up of consumer inflation in June 2023, food inflation is sharply lower by another 100 bps, energy inflation is deeper into negative while core inflation has fallen by 50 bps, one of the sharpest drops in recent months.

Energy inflation which had dipped into negative in March 2023, continues to remain in negative, and it just got deeper by another 500 basis points in June 2023. In the energy basket, energy commodities (including piped gas) are sharply into negative while energy services have also dipped marginally into negative zone. The Fed had been continuously worried about core inflation at above 5%, but that has now fallen below the 5% mark. The good news is that at 4.0%, the US consumer inflation for June 2023 is just about 100 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 the million dollar question.

Food and energy lower; core inflation also eases 50 bps

Even as the impact of the 500 bps Fed rate hike is manifesting in the form of 610 bps fall in inflation, Fed has hinted at more rate hikes, if necessary. After the pause in June 2023, the Fed task would be tricky in July as there are enough arguments on both sides.

Inflation Basket Category	Jun 2023 (YOY)	May 2023 (YOY)	Inflation Basket Category	Jun 2023 (YOY)	May 2023 (YOY)
Food Inflation	5.70%	6.70%	Core Inflation	4.80%	5.30%
Food at home	4.70%	5.80%	Commodities less food and energy	1.30%	2.00%
Cereals and bakery products	8.80%	10.70%	Apparel	3.10%	3.50%
Meats, poultry, fish, and eggs	-0.20%	0.30%	New vehicles	4.10%	4.70%
Dairy and related products	2.70%	4.60%	Used cars and trucks	-5.20%	-4.20%
Fruits and vegetables	3.00%	2.70%	Medical care commodities	4.20%	4.40%
Non-alcoholic beverages	7.60%	8.70%	Alcoholic beverages	4.40%	4.80%
Other food at home	7.10%	9.20%	Tobacco and smoking products	5.80%	6.30%
Food away from home	7.70%	8.30%	Services less energy services	6.20%	6.60%
Full service meals and snacks	6.20%	6.80%	Shelter	7.80%	8.00%
Limited service meals	7.80%	8.00%	Rent of primary residence	8.30%	8.70%
Energy Inflation	-16.70%	-11.70%	Owners’ equivalent rent	7.80%	8.00%
Energy commodities	-26.80%	-20.40%	Medical Care Services	-0.80%	-0.10%
Fuel oil	-36.60%	-37.00%	Physician Services	0.50%	-0.10%
Gasoline (all types)	-26.50%	-19.7%	Hospital Services	4.10%	3.70%
Energy services	-0.90%	1.60%	Transport Services	8.20%	10.20%
Electricity	5.40%	5.90%	Motor vehicle Maintenance	12.70%	13.50%
Natural gas (piped)	-18.60%	-11.00%	Motor vehicle insurance	16.90%	17.10%
Headline Consumer Inflation	3.00%	4.00%	Airline Fare	-18.90%	-13.40%

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 are also marginally in the negative now. Core inflation has eased by 50 bps to 4.80%, but economists feel that the core inflation needs to tend to 3% if the 2% headline inflation target has to be met.

MOM inflation bounces slightly to 0.2% in June 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 2022, MOM inflation stayed below 1% all through. In April 2023, MOM inflation was back at 0.4%, but May 2023 again saw MOM inflation softening back to 0.1%. June has seen MOM inflation higher at 0.2%.

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

1. MOM food inflation rose 0.1% compared to May 2023. Only 2 out of the 6 store food categories saw higher inflation viz. fruits & vegetables and cereals  / bakery products.

    

2. Energy index rose 0.6% MOM in June 2023 as gasoline prices jumped 1.0%. Downward pressure is seen in commodities while energy services are holding up.

    

3. Core inflation again rose 0.2% MOM in June 2023; lower than in May.  The pressure comes from the shelter index rising 0.4% and index for rent rising by 0.5% in June 2023.

RBI would be watching the July Fed policy with interest

How would the RBI and the Indian economy react to the latest inflation data? Certainly, the next big data point for the global economy will be the Fed meeting on July 26, 2023. The interesting part of the story is that July could actually pose a policy dilemma for the Fed and the final decision could have implication for the RBI too. The Fed had paused in June, almost telling the world that a 25 bps rate hike was inevitable in July. Even the CME Fedwatch appears to corroborate that view, but things could change with the latest inflation data.

For the RBI, the US Fed decision remains critical for what has happened in the last two months. In May, India’s consumer inflation had touched 4.25%, just 25 bps short of the target of 4%. However, in June 2023, the consumer inflation had bounced back to 4.81%, now 81 bps away from the target. In the US case, inflation in May had touched 4%, still 200 bps short of the target. However, in June 2023, consumer inflation has touched 3%, just 100 bps short of the target. In short, the US and India are almost at par now with reference to the target inflation rate. That is what makes the US Fed decision critical for the RBI.

For now, the FPIs appear to have applauded the RBI decision to pause twice, infusing more than $14 billion into Indian equities in the last 75 days. The question is what does the RBI do at this point in terms of monetary policy. If the Fed announces another pause in July 2023, then RBI would feel a lot more comfortable. However, despite the fall in inflation, if the Fed was to stick to its 25 bps rate hike stance, then the RBI may have a policy dilemma. For now, all eyes will stay rivetted on the Fed policy on July 26, 2023.