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US August inflation falls 40 bps to 2.5% as energy costs dip

12 Sep 2024 , 11:49 AM

LAST BIG DATA POINT BEFORE FOMC MEET

The August 2024 consumer (CPI) inflation announced by the US Bureau of Labour Statistics (BLS) on September 11, 2024 came in 40 bps lower at 2.5%, compared to 2.9% in July 2024. Interestingly, the food inflation in August was just down by 10 bps while the core inflation was flat at 3.2%. The entire downward thrust in consumer inflation for August came from energy inflation, which dipped deep into the negative. We will come back to that later.

What is material is that the US consumer inflation was the last big data point before the FOMC puts out its policy statement on September 18, 2024. There were 2 big data points in August for the FOMC. Firstly, the labour data showed higher non-farm payroll additions at 142K, but unemployment rate was down only 10 bps to 4.2%. That keeps the risk of hard landing open. Secondly, lower consumer inflation at 2.5%, brings it at par with PCE inflation and makes a strong case for a rate cut; which could either be 25 bps or 50 bps in September.

SETTING IS PERFECT FOR FED TO EMBARK ON RATE CUTS

When it comes to the trajectory of rates, there appears to be a huge dichotomy between what the Fed has been suggesting and what the CME Fedwatch is indicating. For instance, Jerome Powell, speaking at Jackson Hole last month, underlined that he did not immediately foresee more than one rate cut this year. However, the CME Fedwatch is pencilling in a rate cut of 25 bps to 50 bps in September and up to 100 bps in rate cuts by December 2024 and 225 to 250 bps of rate cuts by the end of 2025. It should be clearer after September 2024.

That does sound aggressive and the Fed is yet to crystallize its stand. However, the undertone has changed distinctly dovish; in the light of robust GDP growth, spike in the rate of unemployment and lower inflation, the setting is perfect for the Fed to embark on rate cuts in September. Once the first rate cut takes place, probability of further rate cuts would evolve more clearly. For August 2024, the headline inflation at 2.5% was lower than the street expectation of 2.6%. However, there are some concerns over core inflation refusing to budge below the 3.2% mark, while the lower inflation thrust is coming from energy.

LOWER AUG-24 HEADLINE INFLATION TRIGGERED BY ENERGY BASKET

In the last few months, the energy inflation had been the swing factor while core inflation was trending lower and food inflation was relatively stable. For August 2024, food inflation is marginally lower at 2.1%, and core inflation is static at 3.2%. However, it is energy inflation which has fallen sharply by 510 bps to +1.1% to -4.0%. With Brent crude dipping below the psychological $70/bbl, the immediate risk of any oil price hike is done and dusted. Also, the demand for gasoline has come down in the US and that is also driving energy inflation lower. However, even after the sharp fall, the consumer inflation is still about 50 bps away from the Fed long term target of 2.0%. The table below captures the monthly data on the inflation break-up for August 2024 versus July 2024.

Inflation Basket

Category

Aug 2024 (YOY) Jul 2024 (YOY) Inflation Basket

Category

Aug 2024 (YOY) Jul 2024 (YOY)
Food Inflation 2.10% 2.20% Core Inflation 3.20% 3.20%
Food at home 0.90% 1.10% Commodities less food and energy -1.90% -1.90%
·          Cereals and bakery products -0.30% 0.00% ·          Apparel 0.30% 0.20%
·          Meats, poultry, fish, and eggs 3.20% 3.00% ·          New vehicles -1.20% -1.00%
·          Dairy and related products 0.40% -0.20% ·          Used cars and trucks -10.40% -10.90%
·          Fruits and vegetables -0.20% -0.20% ·          Medical care commodities 2.00% 2.80%
·          Non-alcoholic beverages 1.30% 1.90% ·          Alcoholic beverages 1.90% 1.90%
·          Other food at home 0.40% 0.90% ·          Tobacco and smoking products 8.40% 7.90%
Food away from home 4.00% 4.10% Services less energy services 4.90% 4.90%
·          Full service meals and snacks 3.80% 3.80% Shelter 5.20% 5.10%
·          Limited service meals 4.30% 4.30% ·          Rent of primary residence 5.00% 5.10%
Energy Inflation -4.00% 1.10% ·          Owners’ equivalent rent 5.40% 5.30%
Energy commodities -10.10% -2.00% Medical Care Services 3.20% 3.30%
·          Fuel oil -12.10% -0.30% ·          Physician Services 0.60% 0.70%
·          Gasoline (all types) -10.30% -2.20% ·          Hospital Services 6.10% 6.10%
Energy services 3.10% 4.20% Transport Services 7.90% 8.80%
·          Electricity 3.90% 4.90% ·          Motor vehicle Maintenance 4.10% 4.60%
·          Natural gas (piped) -0.10% 1.50% ·          Motor vehicle insurance 16.50% 18.60%
Headline Consumer Inflation 2.50% 2.90% ·          Airline Fare -1.30% -2.80%

Data Source: US Bureau of Labour Statistics

One point to note is that the US Federal Reserve still uses the PCE inflation as the benchmark for rate decisions. There are 2 reasons for the same. Firstly, PCE inflation looks at inflation from the personal consumption expenditure perspective and, hence, that is more relevant for rate decisions. Secondly, while consumer inflation is published in the second week of the month, the PCE inflation is published in the fourth week of the month, so it incorporates more data points. However, CPI inflation acts as the lead indicator for PCE inflation and also sets the tone for PCE inflation. Here are key takeaways from the data.

  • Let us start with food inflation. Between July 2024 and August 2024, food inflation was down 10 bps at 2.1%. The upward thrust to food inflation came from meat, poultry, fish, and dairy products. In short, the high protein diet is still under price pressure. On the other hand, the downward pressure on prices came from cereals, non-alcoholic beverages, and other food at home.
  • Energy inflation cracked sharply by 510 bps from 1.1% to -4.0%. In the energy basket, there was not a single item that showed an increase, as all items of the energy basket were under pressure due to the high base effect. Some of the items in the energy basket that really fell sharply were fuel oil and gasoline, while the fall in prices of electricity and natural gas was much lesser.
  • Finally, let us turn to the core inflation, which was flat at 3.2% in August 2024. The upward pressure came from tobacco and smoking products, airline fares, apparel, used cars and owner’s equivalent rent. On the other hand, items that exerted downward pressure on the core inflation included new vehicles, medical care commodities, transport services, and motor vehicles maintenance.

While the headline CPI inflation still remains 50 bps above the 2% inflation target, what is gratifying is that energy inflation has sobered substantially, and the journey to 2% inflation is now more a question of when rather than whether.

AUG 2024 MOM INFLATION FLAT

The US Bureau of Labour Statistics (BLS) reports inflation on yoy basis, as well as on MOM high frequency basis. Here is the month-on-month (MOM) inflation for last 6 months.

Month Food (MOM) Fuel (MOM) Core (MOM) Headline (MOM)
Mar 2024 0.1% 1.1% 0.4% 0.4%
Apr 2024 0.0% 1.1% 0.3% 0.3%
May 2024 0.1% (2.0%) 0.2% 0.0%
Jun 2024 0.2% (2.0%) 0.1% (0.1%)
Jul 2024 0.2% 0.0% 0.2% 0.2%
Aug 2024 0.1% (0.8%) 0.3% 0.2%

Data Source: US BLS (negative figures in brackets)

The headline MOM inflation in August 2024 was flat at 0.2%. While short term pressure on the core sector is visible,  it was more than made up by the sharp fall in energy inflation MOM. On an MOM basis, food inflation was 10 bps lower at 0.1% while core inflation was 10 bps higher at 0.3%. Oil fell 80 bps yoy to -0.80%. Here is what we read from the break-up of the MOM US consumer inflation for August 2024.

  1. MOM food inflation in August 2024 was up a modest 0.1%. Out of the 6 store food categories; 2 saw an increase in inflation for meat, poultry, fish, and eggs saw an increase in the index. The lower inflation came from non-alcoholic beverages, food fruits & vegetables, other food at home, and bakery products in August 2024.
  2. The MOM Energy inflation decreased 0.8% in August 2024 over July. The gasoline index fell by 0.6% on a MOM basis, electricity index fell by 0.7%, and natural gas index fell by 1.9% in August.
  3. The MOM Core inflation growth was 0.3% in August 2024 as compared to 0.2% in July 2024. The upward pressure comes shelter index at 0.5%, owners equivalent rent up by 0.5, and lodging away from home up 1.8%, airline fares 3.9% and motor vehicle insurance up by 0.6%. Indexes for apparel and education were also higher.

Overall, the high frequency MOM inflation saw a small bounce in August 2024 with most of the pressures coming from the core sector basket.

CME FEDWATCH OPTIMISTIC ABOUT RAPID RATE CUTS

The best way to understand the shift in CME Fedwatch probabilities as a result of the inflation announcement is to compare the CME Fedwatch before and after the consumer inflation announcement. Let us first look at the CME Fedwatch prior to the latest CPI inflation data. Even prior to the latest inflation reading, the CME Fedwatch was already putting a high probability on aggressive rate cuts. These are captured below.

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 17.6% 53.5% 28.9% Nil
Dec-24 Nil Nil Nil Nil Nil 12.3% 42.7% 36.3% 8.7% Nil Nil
Jan-25 Nil Nil Nil 5.6% 26.1% 39.8% 23.8% 4.8% Nil Nil Nil
Mar-25 Nil 1.8% 12.2% 30.5% 34.7% 17.7% 3.2% Nil Nil Nil Nil
May-25 1.7% 11.8% 29.8% 34.5% 18.3% 3.8% 0.1% Nil Nil Nil Nil
Jun-25 9.3% 23.4% 32.8% 24.1% 9.0% 1.4% Nil Nil Nil Nil Nil
Jul-25 19.9% 27.7% 28.9% 17.2% 5.5% 0.8% Nil Nil Nil Nil Nil
Sep-25 28.9% 28.0% 25.1% 13.4% 4.0% 0.5% Nil Nil Nil Nil Nil
Oct-25 35.5% 27.4% 22.3% 11.2% 3.2% 0.4% Nil Nil Nil Nil Nil
Dec-25 38.7% 26.8% 21.0% 10.3% 2.9% 0.4% Nil Nil Nil Nil Nil

Data source: CME Fedwatch (# – lower probabilities consolidated)

The above table shows how the CME Fedwatch looked before the US consumer inflation reading was announced on September 11, 2024. As you can see, the markets are already pegging 75 bps rate cuts by the end of 2024. It is likely to gather momentum post the inflation announce. Here is how the picture of CME Fedwatch changed after the consumer inflation announcement by the US BLS on September 11, 2024.

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 13.0% 87.0%
Nov-24 Nil Nil Nil Nil Nil Nil Nil 6.2% 48.1% 45.8% Nil
Dec-24 Nil Nil Nil Nil Nil 3.7% 31.6% 47.0% 17.7% Nil Nil
Jan-25 Nil Nil Nil 1.9% 17.7% 39.0% 32.3% 9.1% Nil Nil Nil
Mar-25 Nil 0.8% 8.2% 26.2% 36.3% 23.0% 5.5% Nil Nil Nil Nil
May-25 0.7% 8.2% 26.2% 36.3% 23.0% 5.0% Nil Nil Nil Nil Nil
Jun-25 7.2% 21.8% 33.8% 26.1% 9.7% 1.3% Nil Nil Nil Nil Nil
Jul-25 17.4% 27.7% 30.3% 18.2% 5.6% 0.7% Nil Nil Nil Nil Nil
Sep-25 27.3% 28.5% 26.0% 13.8% 3.9% 0.5% Nil Nil Nil Nil Nil
Oct-25 34.3% 27.8% 23.0% 11.4% 3.1% 0.3% Nil Nil Nil Nil Nil
Dec-25 39.2% 27.1% 21.0% 9.9% 2.5% 0.3% Nil Nil Nil Nil Nil

Data source: CME Fedwatch (# – lower probabilities consolidated)

Since the markets had anticipated 2.6% consumer inflation, the actual figure of 2.5% was not too much off the mark. Here is what the CME Fedwatch table above is indicating in terms of the probability of rate cuts in the next 16 months.

  • The CME Fedwatch has assigned a high probability of 87.0% to a 25 bps rate cut in the September meeting; while 50 bps rate cut has a probability of just 13.0%. However, it is the projections beyond September that are hinting at front-loading.
  • The CME Fedwatch assigned a probability of 100.0% to 50 bps rate cuts and 54.3% probability to 75 bps rate cut by November 2024. A 75 bps rate cut by November would, most likely, entail a 50 bps rate cut in September itself.
  • Let us look at the first milestone of December 2024. By then, a 75 bps rate cut is almost a certainty. Also, there is a probability of 84.3% for a 100 bps rate cut. So, it could very well be 50 bps in September 2024 and another 50 bps by December 2024.
  • Probabilities beyond 2024 are still evolving and will offer more clarity once the current year action is visible. Let us look at June 2025. The CME Fedwatch is assigning 98.7% probability for 175 bps rate cuts and 89% chance for 200 bps rate cuts by June 2025.
  • Let us come to the final milestone of December 2025. At this point, the CME Fedwatch is estimating 97.2% probability for 200 bps of rate cuts and a high probability of 87.3% for 225 bps of rate cuts by December 2025. There is a 66.3% probability that Fed could close year 2025 having cut rates by a full 250 bps from here i.e., (2.75%-3.00%).

Let us finally look at a more practically issue of whether such aggressive expectations are justified in volatile market conditions?

IS THE FED LIKELY TO FRONT-LOAD RATE CUTS?

The CME Fedwatch is probably being a little aggressive, but it is not off the point. In a recent speech governor Chris Waller underlined that; while the US delayed front-loading rate hikes in late 2021, they must not delay front-loading rate cuts in 2024. That is likely to be the approach. The labour data is betraying signs of a possible slowdown and that is the last thing that the US economy. If the Fed gets aggressively dovish, then the RBI cannot be a silent spectator. It remains to be seen, what aces the Fed has up its sleeve!

Related Tags

  • CoreInflation
  • FED
  • FederalReserve
  • FuelInflation
  • inflation
  • RedSeaCrisis
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