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.
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.
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.
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!
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