US inflation bounces to 3.4% as energy gains start to fade

12 Jan 2024 , 09:27 AM

US inflation bounces 30 bps to 3.4% in December 2023

The latest consumer inflation print for the US economy for the month of December 2023 has come in sharply higher at 3.4%. That is 30 bps higher than the 3.10% inflation reported in November 2023. What could worry the Fed is that it is getting closer to the 5.70% inflation reported by the US economy in August and September 2023 and it also takes the US Fed farther from its avowed target of 2% inflation. As of December 2023, the 2% inflation target is a full 140 basis points away. If one read the minutes of the December FOMC meet, the Fed was not willing to play to the gallery by giving out a time table on rate cuts. Fed has given a guidance of 3 rate cuts in 2024 and 4 rate cuts in 2025. However, this would be circumscribed by the assumption of price stability. If that does not happen, then Fed may even consider delaying its rate cut plans. These are still early days.

Interestingly, the sharp spike in inflation by 30 bps in December 2023 to 3.4% levels was largely driven by lesser contraction in energy prices. In the last few months, the tapering of crude oil prices had helped the inflation with negative inflation in energy on a yoy basis. For December, the energy inflation is still negative but  it is gradually getting towards the neutral zone. However, what would impress the Fed and the policy makers is that in December food inflation has actually fallen by 20 bps from 2.90% to 2.70% while core inflation has also fallen by 10 bps from 4.00% to 3.90%. These are indications that the December bounce in inflation may just be the outcome of the Red Sear crisis, which has constricted the flow of oil cargo through the Suez Canal. Once that issue is addressed, the assumption is that, it would be back to business as usual. 

Food and core inflation fall; Energy inflation sticky in December 2023

This spike in inflation has come at a time when the PCE inflation has already dipped below the 3% mark and the food inflation and core inflation have been consistently beating a retreat. The month of December was all about energy inflation. Bear in mind that, energy inflation in December was still negative, but it not deeply in the negative as it has been in the last few months. Contrary to previous months, it is the energy commodities that are facing price pressure while energy services are more comfortable in December 2023.

Inflation Basket Category	Dec 2023 (YOY)	Nov 2023 (YOY)	Inflation Basket Category	Dec 2023 (YOY)	Nov 2023 (YOY)
Food Inflation	2.70%	2.90%	Core Inflation	3.90%	4.00%
Food at home	1.30%	1.70%	Commodities less food and energy	0.20%	0.00%
Cereals and bakery products	2.60%	3.40%	Apparel	1.00%	1.10%
Meats, poultry, fish, and eggs	-0.10%	0.10%	New vehicles	1.00%	1.30%
Dairy and related products	-1.30%	-1.40%	Used cars and trucks	-1.30%	-3.80%
Fruits and vegetables	0.30%	0.40%	Medical care commodities	4.70%	5.00%
Non-alcoholic beverages	2.60%	2.90%	Alcoholic beverages	2.50%	2.90%
Other food at home	2.80%	3.30%	Tobacco and smoking products	7.80%	7.70%
Food away from home	5.20%	5.20%	Services less energy services	5.30%	5.50%
Full service meals and snacks	4.50%	4.30%	Shelter	6.20%	6.50%
Limited service meals	5.90%	6.00%	Rent of primary residence	6.50%	6.90%
Energy Inflation	-2.00%	-5.40%	Owners’ equivalent rent	6.30%	6.70%
Energy commodities	-2.90%	-9.80%	Medical Care Services	-0.50%	-0.90%
Fuel oil	-14.70%	-24.80%	Physician Services	-0.60%	-0.70%
Gasoline (all types)	-1.90%	-8.90%	Hospital Services	5.50%	6.30%
Energy services	-1.10%	-0.10%	Transport Services	9.70%	10.1%
Electricity	3.30%	3.40%	Motor vehicle Maintenance	7.10%	8.50%
Natural gas (piped)	-13.80%	-10.40%	Motor vehicle insurance	20.30%	19.20%
Headline Consumer Inflation	3.40%	3.10%	Airline Fare	-9.40%	-12.10%

Data Source: US Bureau of Labour Statistics

The upcoming meeting of the Fed in January will be interesting, especially considering the 30 bps spike in consumer inflation. One can argue that the Fed relies more on PCE inflation for its rate decisions, but it is consumer inflation that sets the tone. This could mean that even PCE inflation may jump back up above the 3% mark in December. Here are some key takeaways from the US consumer inflation factsheet.

• Between July 2023 and September 2023 headline inflation spiked from 3.2% to 3.7%. This was despite the food inflation falling by 120 bps from 4.90% to 3.70%. In December 2023, food inflation has again fallen 20 bps from 2.90% to 2.70%. 

   

• If you look at the components of the food basket, then all the items in the food basket are seeing lower inflation except for dairy products, where the contraction in prices has actually declined in the month of December 2023.

   

• The real action was in the energy basket. From -5.50% in November 2023, energy inflation has risen sharply to -2.00% in December 2023 and this can be largely attributed to the disruption in global oil prices on account of the ongoing Red Sea Crisis. Energy products have become dearer in December while energy services became cheaper.

   

• Core inflation has eased by 10 bps in December to 3.90%, after staying flat at 4.00% in the month of November. Between August and October, core inflation fell sharply from 4.70% to 4.00%. The level of 3.90% core inflation in December 2023, reflects the lowest level of core inflation in the last 30 months. The persistent fall in core inflation is good since this inflation is structural in nature. However, it is the real estate rentals that continues to be the biggest driver of core inflation on the upside.

MOM inflation up from 0.1% to 0.3% in December 2023

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)	Inflation (MOM)
Jul 2023	0.2%	0.1%	0.2%	0.2%
Aug 2023	0.2%	5.6%	0.3%	0.6%
Sep 2023	0.2%	1.5%	0.3%	0.4%
Oct 2023	0.3%	-2.5%	0.2%	0.0%
Nov 2023	0.2%	-2.3%	0.3%	0.1%
Dec 2023	0.2%	0.4%	0.3%	0.3%

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. In the last two months the headline MOM inflation has spiked, hinting at high frequency pressure on prices.

1. MOM food inflation in December 2023 was flat at 0.2%. A total of 4 out of the 6 store food categories saw higher inflation. Eggs & meat spiked 0.5%, dairy 0.3%, and non-alcoholic beverages 0.2%. Cereals and bakery products were subdued in the month.

    

2. Energy index gained rose 0.4% MOM in December compared to contraction in last 2 months. It was a reverse case of energy commodities inflating in the month of December, while energy services were relatively subdued. 

    

3. Core inflation growth was flat at 0.3% in December 2023 MOM.  The inflation pressure comes largely from shelter and rent, which was the big driver of MOM core inflation at 0.5% and 0.4% respectively. Used cars and motor vehicles insurance costs also went up in December. Household furnishings and personal care products saw a sharp fall in the month, which actually helped the MOM core sector index to stay flat.

How the CME Fedwatch changed post the Inflation data?

The market impact of higher inflation is likely to reflect in the CME Fedwatch. These are the probabilities that Fed Futures traders assign to rate cuts over the next 7-8 Fed policies. The table below captures the CME Fedwatch at the end of the previous week and this is after the Fed minutes had disappointed the street.

Fed Meet	300-325	325-350	350-375	375-400	400-425	425-450	450-475	475-500	500-525	525-550
Jan-24	Nil	Nil	Nil	Nil	Nil	Nil	Nil	Nil	6.2%	93.8%
Mar-24	Nil	Nil	Nil	Nil	Nil	Nil	Nil	4.0%	62.3%	33.8%
May-24	Nil	Nil	Nil	Nil	Nil	Nil	3.1%	48.9%	10.3%	7.7%
Jun-24	Nil	Nil	Nil	Nil	Nil	2.9%	47.2%	40.6%	9.0%	0.3%
Jul-24	Nil	Nil	Nil	Nil	2.5%	40.4%	41.6%	13.8%	1.6%	Nil
Sep-24	Nil	Nil	Nil	2.2%	38.9%	41.5%	17.1%	3.1%	0.2%	Nil
Nov-24	Nil	Nil	1.4%	23.7%	39.4%	26.0%	8.2%	1.3%	0.1%l	Nil
Dec-24	Nil	1.1%	19.3%	16.3%	28.6%	11.7%	2.6%	0.3%	Nil	Nil

Data source: CME Fedwatch

The CME Fedwatch as of the end of last week had become slightly mellowed after the Fed minutes did not make any reference to the rate cut time table. As a result, the aggression of the CME Fedwatch had already tapered and the markets were just about making a provision of 6 rate cuts up to 150 bps in calendar 2024. Remember, the Fed has only hinted at 3 rate hikes in 2024 and 4 rate hikes in 2025. So, how has this higher consumer inflation reading for December 2023 impacted the CME Fedwatch? The table below captures the CME Fedwatch data after the consumer inflation data for December was announced by the US Bureau of Labour Statistics (BLS).

Fed Meet	300-325	325-350	350-375	375-400	400-425	425-450	450-475	475-500	500-525	525-550
Jan-24	Nil	Nil	Nil	Nil	Nil	Nil	Nil	Nil	2.6%	97.4%
Mar-24	Nil	Nil	Nil	Nil	Nil	Nil	Nil	1.8%	67.1%	31.2%
May-24	Nil	Nil	Nil	Nil	Nil	Nil	1.6%	60.1%	35.0%	3.3%
Jun-24	Nil	Nil	Nil	Nil	0.1%	5.1%	56.6%	34.7%	3.5%	Nil
Jul-24	Nil	Nil	Nil	0.1%	4.8%	53.0%	36.2%	5.7%	0.2%	Nil
Sep-24	Nil	Nil	0.1%	4.4%	49.1%	37.5%	8.1%	0.7%	Nil	Nil
Nov-24	Nil	0.1%	2.7%	32.0%	42.0%	19.4%	3.5%	0.3%	Nil	Nil
Dec-24	Nil	2.1%	25.3%	39.8%	24.5%	7.1%	1.0%	0.1%	Nil	Nil

Data source: CME Fedwatch

Actually, if you compare the CME Fedwatch post the inflation announcement on January 11, 2023; which was tad higher than last month, the caution is only seen in the first quarter. After that, the CME Fedwatch continues to believe that the Fed will cut rates aggressive and also front end the rate cuts. In fact, the CME Fedwatch was pegging 6 rate cuts by end of 2024, but now after the consumer inflation data on Thursday, the CME Fedwatch is hinting at equal probability allocation between 6 rate cuts and 7 rate cuts in 2024. It looks like the consumer inflation has not dampened the optimism of the CME Fedwatch. If anything, it continues to be very aggressive and expects the Fed to front end rate cuts in 2024. It is yet to crystallize its view on 2025.

Is Fed rate cut time table off for now; and what will RBI do?

With the spike in consumer inflation by 30 bps in December 2023, Fed is unlikely to change its stance or use a more dovish language in the January policy statement. The policy stance would still be cautious as target rates of 2% are 140 bps away now. Fed would wait till headline inflation decisively moves towards 2% and core inflation moves below 3%. Of course, the reference point would still be the PCE inflation for the US Fed. For now, the Fed is unlikely to give any commitment on rate cut timelines.

For the RBI, the US consumer inflation will be a key input as it grapples with rising food inflation in India. In the last few months, the overall headline inflation had fallen from 7.44% to 4.87%, but has since bounced to 5.5% and expected to edge closer to 6% in December. Currently, RBI is on wait-and watch mode, but it also means that with the current inflation expectations, rate cuts would be an impractical expectation in India too. 

The good news for the RBI is that the FPI flows are back with a bang and debt flows would start with the induction of Indian bonds in the JP Morgan and Bloomberg indices. That should harden the rupee and reduce the risk of imported inflation. RBI, obviously, already has a Plan-B in place, in case inflation turns problematic. That is the kind of situation that the RBI would hope not to have!