US December inflation down to 6.5% as hawkishness works

16 Jan 2023 , 07:35 AM

Since then, the glide path of US inflation has been clearly lower and the YOY inflation has come in at 6.5% for December 2022. With the Fed being so aggressive on rate hikes, it is only obvious that inflation had to come down rapidly. In fact, Jerome Powell had already hinted, even before the inflation announcement, that Fed would tone down the aggression from December itself. Apart from reducing the rate hike to 50 bps in December 2022, the Fed minutes also hinted that another 75 bps of rate hike would be spread across 3 Fed meetings. It looks like the Fed raising rates by a full 425 basis points from the range of 0.00%-0.25% to 4.25%-4.50% has done the job.

In October 2022, consumer inflation fell below 8% for the first time since February 2022 after touching a peak of 9.1% in June 2022. Since June, inflation tapered to 8.5%, 8.4%, 8.2%, 7.7% and 7.1% between July and November. The month of December 2022 saw a fall in consumer inflation by another 60 bps to 6.5%. If one looks at the break-up of consumer inflation in December 2022, there has been a sharp fall in energy inflation. However, the tapering of food inflation and core inflation has been more timid. 

Broadly, the yoy inflation was lower across all the 3 major categories viz. food inflation, energy inflation and core inflation; although it has been most pronounced in energy inflation. For instance, Food inflation fell by just 20 bps from 10.6% to 10.4%. During the same period, energy inflation fell 580 basis points from 13.1% to 7.3%. Effectively, energy inflation is down more than 10 percentage points in the last 2 months. Even core inflation tapered another 30 bps from 6.0% to 5.7%. Over last 3 months, core inflation fell 90 bps from 6.6% to 5.7%, which is a good structural signal.

US consumer inflation down 260 bps from June 2022 peak

Headline consumer inflation in the US has now fallen 260 basis points from the peak of June 2022. However, the cumulative impact of rate hikes will translate into a sharper fall in consumer inflation in coming months. All 3 heads viz. food inflation, energy inflation and core inflation are lower. With the rates already 200 bps above the neutral rate, even small rate hikes from here will have a multiplier effect on inflation.

While energy prices are sharply lower in the last 6 months, the concern is that a recovery in China post-COVID relaxations and the total EU ban on Russian oil could prop up oil prices. OPEC will try and keep Brent Crude prices in the range of $90-$100/bbl. Secondly, EU sanctions on diesel from Russia could have the effect of spiking crude oil prices.

Inflation Basket Category	Dec 2022 (YOY)	Nov 2022 (YOY)	Inflation Basket Category	Dec 2022 (YOY)	Nov 2022 (YOY)
Food Inflation	10.40%	10.60%	Core Inflation	5.70%	6.00%
Food at home	11.80%	12.00%	Commodities less food and energy	2.10%	3.70%
Cereals and bakery products	16.10%	16.40%	Apparel	2.90%	3.60%
Meats, poultry, fish, and eggs	7.70%	6.80%	New vehicles	5.90%	7.20%
Dairy and related products	15.30%	16.40%	Used cars and trucks	-8.80%	-3.30%
Fruits and vegetables	8.40%	9.70%	Medical care commodities	3.20%	3.10%
Non-alcoholic beverages	12.60%	13.20%	Alcoholic beverages	5.80%	5.50%
Other food at home	13.90%	13.90%	Tobacco and smoking products	5.50%	6.30%
Food away from home	8.3%	8.50%	Services less energy services	7.00%	6.80%
Full service meals and snacks	8.20%	9.00%	Shelter	7.50%	7.10%
Limited service meals	6.60%	6.70%	Rent of primary residence	8.30%	7.90%
Energy Inflation	7.30%	13.10%	Owners’ equivalent rent	7.50%	7.10%
Energy commodities	0.40%	12.20%	Medical Care Services	4.10%	4.40%
Fuel oil	41.50%	65.70%	Physician Services	1.70%	1.50%
Gasoline (all types)	-1.50%	10.10%	Hospital Services	4.40%	2.90%
Energy services	15.60%	14.20%	Transport Services	14.60%	14.20%
Electricity	14.30%	13.70%	Motor vehicle Maintenance	13.00%	11.70%
Natural gas (piped)	19.30%	15.50%	Motor vehicle insurance	14.20%	13.40%
Headline Consumer Inflation	6.50%	7.10%	Airline Fare	28.50%	36.00%

Data Source: US Bureau of Labour Statistics

There are a few broad trends emerging. Firstly, food inflation has fallen on a yoy basis, but remains 0.3% higher on a sequential basis. In the food basket, vegetables and fresh fruits saw lower inflation while high protein items like meat and eggs saw a spike in inflation, showing the lag effect of supply side constraints. Secondly, under the energy category, the fall in energy inflation has been driven by the sharp fall in gasoline prices and fuel; while electricity and piped gas prices are actually higher. Lastly, core inflation has tapered, but while product inflation is tapering, services inflation is still rising.

High frequency inflation negative for the first time in 2022

The US Bureau of Labour Statistics (BLS) reports inflation on a yoy basis, and on MOM high frequency basis. After touching a high of 1.3% in June, it fell to 0.0% in July 2022. While MOM inflation spiked in September and October, it had moderated in November 2022 to 0.1% on a seasonally adjusted basis. December has seen high frequency MOM headline inflation dip into the negative for the first time in the year 2022.

Here are key takeaways from the MOM inflation data for December 2022.

1. MOM food inflation increased 0.3% with 3 out of 6 heads of groceries up. Inflation was higher for meat, fish, poultry and eggs but lower for vegetable and fruits.

    

2. Energy index fell -4.5% MOM in December with gasoline prices falling sharply but a spike in the price of natural gas for the month.

    

3. Core inflation rose 0.3% MOM in December 2022. Pressure is coming from services even as the goods are driving core inflation lower.

Fed will go slow, but not give up on rate hikes

Fed stands at the policy cross roads. It hiked rates by 425 bps and headline consumer inflation is down 260 bps. Here is what we can expect from the Fed in the coming months.

1. Fed is now expected to hike rates by another 75 bps in 2023, which would most likely happen in 3 tranches of 25 basis points each. Hence the impact on the financial markets would be limited since this is already factored in.

    

2. Fed minutes already clarified that there would not be any rate cuts in 2023 and the first rate cuts may be possible only in year 2024. More so, since GDP growth is not an issue with the Q3 GDP turning around to positive territory for the US economy.

    

3. The joker in the pack is inflation. There are several X-factors. There is the reopening of the Chinese economy which could spike inflation. Secondly, the OPEC will still try to constrict supply, and the EU ban on Russia could add to the supply shortfall in the global market. These factors could push up oil prices and inflation.

    

4. Finally, what are the implications for India? RBI is in sync with the US economy on rates and with inflation falling in both the economies, India does not have to worry about risk-off flows. In the US and in India, the shift out of inflation control and towards a growth supportive policy is clear.