US February 2024 inflation gives a surprise spike to 3.2%

13 Mar 2024 , 10:11 AM

OIL LEADS US CONSUMER INFLATION HIGHER

For the month of February 2024, the US consumer inflation was up 10 bps at 3.2%. That takes it a tad farther from the target of 2%, and it is now a full 120 bps away from its eventual long-term target. When the Bureau of Labour Statistics (BLS) announced the consumer inflation for the month of February 2024, it was expected to be marginally lower; or flat at best. However, the 10 bps did come as a surprise. It had the impact of making the CME Fedwatch the least dovish in recent memory; a point we will cover in detail later in this piece. The PCE inflation has been steadily trending lower and is already at 2.4%, indicating that the consumption was being curtailed by higher rates. However, the impact on the consumer inflation comes more from energy prices; since core inflation was marginally lower in February, compared to January 2024; while food inflation was 40 bps down. In January 2024, the inflation reading came in lower; but it was 20 bps above street estimates. This time, in February 2024, consumer inflation has actually come in higher at 3.2%.

YES, IT WAS THE RED SEA CRISIS ALL OVER AGAIN

For the month of February 2024, there was a rather sharp 40 bps fall in food inflation and 10 bps fall in structural core inflation. However, the pressure came from energy inflation, although it continued to be in the negative zone. This is apparently reflective of the new set of supply chain bottlenecks created by the Red Sea crisis, which has seriously disrupted global trade. One of the busiest trade routes connecting the US and Europe with Asia through the Mediterranean and the Red Sea stands disrupted and that is crating most of the havoc on world trade. Ships are forced to take the circuitous route via the Horn of Africa; which is adding to freight costs and insurance costs; even while disrupting cargo schedules.

FOOD PRICES FALL SHARPLY, BUT ENERGY HARDENS IN FEBRUARY 2024

There was a sharp fall in Food at Home and Food away from Home categories, leading to a 40 bps fall in food inflation to 2.2% in February 2024. However, the real pressure point was energy as fuel oil and gasoline hardened in February. Even under core inflation, some of the fuel related heads like transportation and airline fares saw resultant pressure building up.

Inflation Basket Category	Feb 2024 (YOY)	Jan 2024 (YOY)	Inflation Basket Category	Feb 2024 (YOY)	Jan 2024 (YOY)
Food Inflation	2.20%	2.60%	Core Inflation	3.80%	3.90%
Food at home	1.00%	1.20%	Commodities less food and energy	-0.30%	-0.30%
·          Cereals and bakery products	1.70%	1.50%	·          Apparel	0.00%	0.10%
·          Meats, poultry, fish, and eggs	-0.50%	-0.90%	·          New vehicles	0.40%	0.70%
·          Dairy and related products	-1.80%	-1.10%	·          Used cars and trucks	-1.80%	-3.50%
·          Fruits and vegetables	0.80%	1.10%	·          Medical care commodities	2.90%	3.00%
·          Non-alcoholic beverages	2.30%	3.40%	·          Alcoholic beverages	2.40%	2.30%
·          Other food at home	2.30%	2.60%	·          Tobacco and smoking products	7.10%	7.40%
Food away from home	4.50%	5.10%	Services less energy services	5.20%	5.40%
·          Full service meals and snacks	3.80%	4.30%	Shelter	5.70%	6.00%
·          Limited service meals	5.20%	5.80%	·          Rent of primary residence	5.80%	6.10%
Energy Inflation	-1.90%	-4.60%	·          Owners’ equivalent rent	6.00%	6.20%
Energy commodities	-4.20%	-6.90%	Medical Care Services	1.10%	0.60%
·          Fuel oil	-5.40%	-14.20%	·          Physician Services	0.40%	-0.10%
·          Gasoline (all types)	-3.90%	-6.40%	·          Hospital Services	6.10%	6.70%
Energy services	+0.50%	-2.00%	Transport Services	9.90%	9.50%
·          Electricity	3.60%	3.80%	·          Motor vehicle Maintenance	6.70%	6.50%
·          Natural gas (piped)	-8.80%	-17.80%	·          Motor vehicle insurance	20.60%	20.60%
Headline Consumer Inflation	3.20%	3.10%	·          Airline Fare	-6.10%	-6.40%

Data Source: US Bureau of Labour Statistics

While the Fed still relies on PCE inflation for rate decisions, the consumer inflation does set the tone for the month. There is an important FOMC meeting coming up in March and the Fed has already indicated that March rate cuts were unlikely. With the inflation coming in 10 bps higher, it now looks like even May rate cuts may be ruled. Even the CME Fedwatch is now expecting the first rate cut to only happen in June policy. For February 2024, the food inflation fell sharply while core inflation was marginally lower. The pressure came from energy inflation for obvious reasons. Here are some key takeaways.

• Let us talk about food inflation. Between January 2024 and February 2024, food inflation tapered by 40 bps from 2.60% to 2.20%. The sharpest fall in prices was visible in dairy products, non-alcoholic beverages, fruits & vegetables, and food away from home. However, items like cereals, dairy and meat saw a spike in prices in January 2024.
• The energy inflation picked up by another 270 bps, negating the salutary January impact. Prices of energy commodities and energy services spiked in February. The big pressure came from fuel and gasoline prices. While electricity prices tapered, piped gas prices were sharply higher in the month of February 2024; compared to January reading.
• Finally, let us turn to the core inflation, which was 10 bps lower at 3.8% compared to January 2024. Interestingly, most of the items in the core basket that faced pressure were either directly or indirectly linked to higher fuel prices. Used cars and trucks saw higher price inflation while transportation costs went up sharply and airline fares also came under pressure due to the resultant effect of higher fuel inflation. Among other services, healthcare costs have also seen a spike in February 2024.

If January inflation was higher than expected by the street; the February 2024 inflation was actually higher by 10 bps. While it can be dismissed as energy inflation, the challenge is that this is also starting to have its trickle-down effect on specific items in the core basket.

MOM INFLATION RISES TO 0.4% IN FEBRUARY 2024

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)
Sep 2023	0.2%	1.5%	0.3%	0.4%
Oct 2023	0.3%	-2.5%	0.2%	0.0%
Nov 2023	0.2%	-1.6%	0.3%	0.2%
Dec 2023	0.2%	-0.2%	0.3%	0.2%
Jan 2024	0.4%	-0.9%	0.4%	0.3%
Feb 2024	0.0%	2.3%	0.4%	0.4%

It is interesting to see how the headline MOM inflation has panned out. Between July and August 2023, MOM inflation spiked from 0.2% to 0.6% but tapered back to 0.4% in September and further to 0.0% in October. However, like in January 2024, even February 2024 saw headline MOM inflation spiking to 0.4%.

1. MOM food inflation in February 2024 was flat at 0.0%. A total of 3 out of the 6 store food categories saw higher inflation. The lower inflation came from dairy products, and fruits & vegetables while the MOM inflation was higher for cereals, bakery products, and poultry for the month of February 2024.
2. Energy index spiked sharply by 2.3% MOM in February 2024. The gasoline index spiked by 3.8% while piped gas also spiked by 2.3% in the month of February 2024. The index for fuel and electricity were also higher in the month. Most of the short term pressures on the energy index emanated from the Red Sea crisis.
3. Core inflation growth was higher by 0.4% MOM in February 2024. The inflation pressure comes largely from shelter index at 0.4% and for rentals at 0.5%. Among other items, the index for airline fares and for motor vehicle insurance were also up. It was more the downstream pressure of higher oil prices.

FEBRUARY CPI INFLATION MADE CME FEDWATCH MORE DOVISH

The market impact of higher inflation was likely to reflect in the CME Fedwatch. Given below are the probabilities that Fed Futures traders assign to rate cuts over the next 10 Fed policies. The table below captures CME Fedwatch at the end of the previous week, prior to the February US inflation data announcement.

Fed Meet	300-325	325-350	350-375	375-400	400-425	425-450	450-475	475-500	500-525	525-550
Mar-24	Nil	Nil	Nil	Nil	Nil	Nil	Nil	Nil	3.0%	97.0%
May-24	Nil	Nil	Nil	Nil	Nil	Nil	Nil	0.6%	21.2%	78.2%
Jun-24	Nil	Nil	Nil	Nil	Nil	Nil	0.4%	15.1%	61.4%	23.1%
Jul-24	Nil	Nil	Nil	Nil	Nil	0.3%	10.3%	46.2%	35.7%	7.6%
Sep-24	Nil	Nil	Nil	Nil	0.2%	8.8%	40.8%	37.2%	11.8%	1.1%
Nov-24	Nil	Nil	Nil	0.1%	5.2%	27.2%	38.8%	22.6%	5.7%	0.5%
Dec-24	Nil	Nil	0.1%	4.0%	22.0%	36.0%	26.4%	9.7%	1.7%	0.1%
Jan-25	Nil	0.1%	2.7%	15.1%	30.1%	29.9%	16.3%	5.0%	0.8%	Nil
Mar-25	Nil	1.3%	8.3%	21.8%	29.9%	23.7%	11.3%	3.2%	0.5%	Nil
Apr-25	0.9%	6.3%	18.0%	27.6%	25.5%	14.8%	5.5%	1.2%	0.2%	Nil

Data source: CME Fedwatch

The above table shows how the CME Fedwatch looked ahead of the US inflation reading. The markets were expecting about 75 to 100 bps rate cut by the end of 2024 and, possibly stretching up to 125 to 150 bps by June 2025. This is in sharp contrast to initial aggression shown by the CME Fedwatch. Let us now turn to how CME Fedwatch shifted its stance after the US February 2024 inflation came in 10 bps higher at 3.2%.

Fed Meet	300-325	325-350	350-375	375-400	400-425	425-450	450-475	475-500	500-525	525-550
Mar-24	Nil	Nil	Nil	Nil	Nil	Nil	Nil	Nil	1.0%	99.0%
May-24	Nil	Nil	Nil	Nil	Nil	Nil	Nil	0.1%	14.5%	85.4%
Jun-24	Nil	Nil	Nil	Nil	Nil	Nil	0.1%	8.8%	57.3%	33.8%
Jul-24	Nil	Nil	Nil	Nil	Nil	Nil	5.1%	36.9%	43.7%	14.3%
Sep-24	Nil	Nil	Nil	Nil	Nil	4.0%	29.9%	42.2%	20.7%	3.1%
Nov-24	Nil	Nil	Nil	Nil	2.1%	17.7%	36.4%	30.9%	11.4%	1.5%
Dec-24	Nil	Nil	Nil	1.6%	13.6%	31.4%	32.3%	16.6%	4.1%	0.4%
Jan-25	Nil	Nil	0.9%	8.6%	24.0%	32.0%	23.1%	9.3%	1.9%	0.2%
Mar-25	Nil	0.6%	5.5%	17.8%	28.7%	26.7%	14.9%	4.9%	0.9%	0.1%
Apr-25	0.3%	3.2%	12.0%	23.5%	27.7%	20.5%	9.6%	2.8%	0.5%	Nil

Data source: CME Fedwatch

The higher US consumer inflation has made the CME Fedwatch more dovish. Now, the CME Fedwatch is only pegging about 50 bps to 75 bps of rate cuts by end of 2024, which is lower than the Fed stance. For 2025, the CME Fedwatch is pegging rate cuts of up to 100 to 125 bps by the middle of 2025. That has not changed much since the end of last week as the CME Fedwatch still expects the rate cuts to be back-ended, rather than front-ended. However, a clearer picture will only emerge after the Fed takes up the first rate cuts; which looks likely only in the June 2024 policy statement. The Red Sea crisis has made the Fed more cautious and the CME Fedwatch is now reflecting the Fed caution more vividly.

WHEN WILL FED CUT RATES; AND WHAT ABOUT RBI?

It may be recollected that the Fed had already ruled out rate cuts in March and with the current inflation reading, even May looks unlikely. The earliest that we can hope for is a rate cut in June, which looks fairly likely at this point of time. A lot would still depend on how the oil prices shape up in the light of the ongoing Red Sea crisis. In February, it is not just the YOY inflation; but even the high frequency MOM inflation is evincing pressure. Clearly, the Fed is going to move cautiously. While PCE inflation will be the real driving factor, the gap between consumer inflation of 3.2% and the target of 2.0% would still be a concern.

For the RBI, the US consumer inflation remains a key input as it grapples with sticky inflation in India. Even the February reading has shown CPI inflation flat, but food inflation spiking by 36 basis points to 8.66%. Currently, the RBI is on wait-and watch mode, but it is unlikely to act with the current inflation risks. It would still prefer the strategy of holding rates higher for longer. For the RBI, the other considerations would be the upcoming general elections and its impact on inflation. Ideally, the RBI would prefer that the new government is in place by end of May and the full budget presented by early or mid-July 2024. Any rate cut action is only likely after that.