US inflation falls to 3.1% as food and energy prices taper

14 Feb 2024 , 09:32 AM

Despite the fall, US inflation disappoints

Ideally, any fall in inflation should be seen as positive by the markets. However, on Tuesday, when the Bureau of Labour Statistics (BLS) announced the consumer inflation for the month of January 2024, there was a sense of disappointment. To be fair, the inflation for January was 30 bps lower than December 2023. The headline US consumer inflation had fallen from 3.4% in December 2023 to 3.1% in January 2024. However, the street was expecting the headline inflation to fall to around 2.9%. Remember, the PCE inflation is already at 2.6%, and hence a sharper inflation was expected in the consumer inflation also. But what really disappointed the markets was the fact that the core inflation (net of food and fuel), had remained static at 3.9%, the same level as the previous month.

Red Sea crisis creates supply chain bottlenecks

For the month of January 2024, there was a marginally 10 bps fall in food inflation and a perceptible lowering of energy inflation. However, the core inflation stayed put at 3.9%. Now, core inflation reflects the structural aspect of inflation and in the last one year, it had steadily fallen on the back of the easing of supply chain bottlenecks. However, the static core inflation, according to experts, is reflective of the new set of supply chain bottlenecks created by the ongoing Red Sea crisis, which has forced most cargo ships traversing the region to take the more circuitous route around the Horn of Africa. The core inflation was expected to fall to 3.7% while the food inflation was expected to fall better than 10 bps. On both fronts, the inflation reading disappointed in the month of January 2024.

Food and energy inflation abate, core inflation static in January 2024

The fall in consumer inflation to 3.1% just takes it back to the level of November 2023 and negates the spike of December. That was hardly impressive and much higher than the Bloomberg estimates of 2.9% inflation. This also raises the possibility that the PCE inflation to be announced towards the end of this month, could bounce higher from 2.6%. The PCE inflation is critical as it is the guiding factor for the Fed on the future trajectory of interest rates. For now, this gives the Fed a reason to justify its hawkish stance and delay rate cuts.

Inflation Basket Category	Jan 2024 (YOY)	Dec 2023 (YOY)	Inflation Basket Category	Jan 2024 (YOY)	Dec 2023 (YOY)
Food Inflation	2.60%	2.70%	Core Inflation	3.90%	3.90%
Food at home	1.20%	1.30%	Commodities less food and energy	-0.30%	0.20%
Cereals and bakery products	1.50%	2.60%	Apparel	0.10%	1.00%
Meats, poultry, fish, and eggs	-0.90%	-0.10%	New vehicles	0.70%	1.00%
Dairy and related products	-1.10%	-1.30%	Used cars and trucks	-3.50%	-1.30%
Fruits and vegetables	1.10%	0.30%	Medical care commodities	3.00%	4.70%
Non-alcoholic beverages	3.40%	2.60%	Alcoholic beverages	2.30%	2.50%
Other food at home	2.60%	2.80%	Tobacco and smoking products	7.40%	7.80%
Food away from home	5.10%	5.20%	Services less energy services	5.40%	5.30%
Full service meals and snacks	4.30%	4.50%	Shelter	6.00%	6.20%
Limited service meals	5.80%	5.90%	Rent of primary residence	6.10%	6.50%
Energy Inflation	-4.60%	-2.00%	Owners’ equivalent rent	6.20%	6.30%
Energy commodities	-6.90%	-2.90%	Medical Care Services	0.60%	-0.50%
Fuel oil	-14.20%	-14.70%	Physician Services	-0.10%	-0.60%
Gasoline (all types)	-6.40%	-1.90%	Hospital Services	6.70%	5.50%
Energy services	-2.00%	-1.10%	Transport Services	9.50%	9.70%
Electricity	3.80%	3.30%	Motor vehicle Maintenance	6.50%	7.10%
Natural gas (piped)	-17.80%	-13.80%	Motor vehicle insurance	20.60%	20.30%
Headline Consumer Inflation	3.10%	3.40%	Airline Fare	-6.40%	-9.40%

Data Source: US Bureau of Labour Statistics

This was one of the key data points that the Fed was watching ahead of the March FOMC meet. However, the Fed has already ruled out any rate cuts in the March FOMC meet, so the markets have not got to shift their expectations to May or June. Compared to December 2023, the food inflation abated and so did energy inflation. However, core inflation remained static and that prevented the headline inflation from falling to 2.9% as was expected in the Bloomberg estimates ahead of the inflation announcement.

• Let us talk about food inflation. Between December 2023 and January 2024, food inflation tapered by 10 bps from 2.70% to 2.60%. The sharpest fall in prices was visible in cereals, poultry, and dairy products. However, some of the other items like fruits & vegetables and non-alcoholic beverages saw a sharp spike in prices in January 20w4.

   

• The energy inflation tapered by another 260 bps, deeper into the negative zone. Prices of energy commodities fell sharply MOM, largely led by gasoline prices. While the prices of natural gas were also sharply lower compared to December 2023, it was the price of electricity that showed a spike in the month of January 2024.

   

• Finally, let us turn to the core inflation, which remained static at 3.9% between December 2023 and January 2024. The Bloomberg estimates had pegged the core inflation lower at 3.7% for January 2024. To be fair, most of the products in the core inflation basket were lower on a MOM basis. This includes apparel, new cars, used cars, shelter, rentals and vehicle maintenance. However, the spike came predominantly in medical and physician services. Motor vehicle insurance and airfares were also higher.

The disappointment for January 2024 stems from the tepid fall in food inflation and the static core inflation. The latter can be largely attributed to the spike in medical and healthcare services during the month of January 2024.

MOM inflation stays stable at 0.3% in January 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)
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%	-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%

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 January 2024, the headline MOM inflation has spiked, hinting at high frequency pressure on prices.

1. MOM food inflation in January 2024 was sharply higher at 0.4%. A total of 4 out of the 6 store food categories saw higher inflation. The pressure came from sugar, fats & oils, other foods, non-alcoholic beverages, and fruits & vegetables. However, inflation in cereals, dairy products and poultry was subdued in January 2024.

    

2. Energy index fell -0.9% MOM in January 2024. Electricity was the only major energy service to see an increase while the prices of gasoline, fuel oil and even natural gas were relatively lower compared to last month. That explained the negative high frequency consumer inflation for the month of January 2024.

    

3. Core inflation growth was higher at 0.4% MOM in January 2024. The inflation pressure comes largely from shelter index at 0.6% and for rentals at 0.4%. Lodging away from home also added to the upward pressure. A bid driver was medical care inflation MOM  while the index for cars & trucks and the apparels index were subdued during January.

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 10 Fed policies. The table below captures the CME Fedwatch at the end of the previous week and before the latest US inflation data was announced.

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	16.0%	84.0%
May-24	Nil	Nil	Nil	Nil	Nil	Nil	Nil	8.5%	52.2%	39.3%
Jun-24	Nil	Nil	Nil	Nil	Nil	Nil	6.8%	43.5%	41.9%	7.8%
Jul-24	Nil	Nil	Nil	Nil	Nil	5.5%	36.4%	42.2%	14.4%	1.5%
Sep-24	Nil	Nil	Nil	Nil	4.7%	32.%	41.4%	18.3%	3.3%	0.2%
Nov-24	Nil	Nil	Nil	2.7%	20.2%	37.4%	28.3%	9.8%	1.6%	0.1%
Dec-24	Nil	Nil	1.9%	14.9%	32.1%	31.1%	15.5%	4.1%	0.5%	Nil
Jan-25	Nil	1.2%	9.9%	25.5%	31.5%	21.4%	8.4%	1.9%	0.2%	Nil
Mar-25	0.5%	4.6%	16.1%	27.9%	27.5%	16.3%	5.9%	1.2%	0.1%	Nil
Apr-25	3.4%	11.8%	23.5%	27.6%	20.5%	9.7%	3.0%	0.5%	0.1%	Nil

Data source: CME Fedwatch

To set the background, let us quickly understand how the CME Fedwatch stood just ahead of the US inflation announcement. The markets are expecting about 100 to 125 bps of rate cuts by the end of 2024 and, possibly stretching up to 150 to 175 bps by June 2025. In contrast to the initial aggression shown by the CME Fedwatch, it now appears to be already veering towards the Fed viewpoint. This shift became a lot more perceptible after the last Fed statement on January 31, 2024 ruled out any rate cuts in the March policy. Let us now turn to how CME Fedwatch shifted its stance post the US January inflation reading at 3.1%.

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	9.0%	91.0%
May-24	Nil	Nil	Nil	Nil	Nil	Nil	Nil	5.7%	61.0%	33.3%
Jun-24	Nil	Nil	Nil	Nil	Nil	Nil	1.2%	17.6%	55.0%	26.2%
Jul-24	Nil	Nil	Nil	Nil	Nil	0.8%	11.9%	42.0%	36.2%	9.1%
Sep-24	Nil	Nil	Nil	Nil	0.6%	9.0%	34.1%	37.7%	16.2%	2.4%
Nov-24	Nil	Nil	Nil	0.3%	5.1%	22.2%	36.1%	26.1%	8.7%	1.1%
Dec-24	Nil	Nil	0.2%	3.3%	16.0%	31.0%	29.9%	15.3%	4.0%	0.4%
Jan-25	Nil	0.1%	2.1%	10.9%	24.9%	30.3%	21.1%	8.5%	1.8%	0.2%l
Mar-25	Nil	0.7%	4.6%	14.9%	26.5%	27.7%	17.6%	6.6%	1.4%	0.1%
Apr-25	0.9%	4.9%	15.3%	26.5%	27.3%	17.2%	6.4%	1.3%	0.1%	Nil

Data source: CME Fedwatch

The US consumer inflation being higher than expected has meant that the CME Fedwatch has veered more towards the Fed stance. Now, the CME Fedwatch is only pegging about 75 bps to 100 bps of rate cuts by end of 2024, which is almost the stance that the Fed has also taken. For 2025, the CME Fedwatch is pegging rate cuts of up to 125 to 150 bps by the middle of 2025. That may still be a little optimistic, but that still has a long way to go and a lot could happen in between. The Fed, in a sense, was justified in sticking to its stance and not committing on rate cuts, or giving any timetable. While the fuel inflation may be lower, the Red Sea crisis has surely put pressure on supply chain and, hence, on core inflation..

Will the Fed delay rate cuts further; and what it means for RBI?

With the consumer inflation being higher than the street expectations and the high frequency MOM inflation showing pressure across the board, the Fed is only likely to be careful. It has sent across its message that the Fed would stick to its viewpoint, irrespective of the market perspective of the CME Fedwatch. That is message enough for the markets. The policy stance will still be cautious as target rates of 2% are 110 bps away. Fed would wait till headline inflation decisively moves towards 2% and core inflation moves below 3%. The PCE inflation this month should give a better picture.

For the RBI, the US consumer inflation remains a key input as it grapples with sticky inflation in India. For January 2024, the India CPI inflation has fallen, but the pressure points remain. 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 RBI may consider rate cuts later in the second half, but for now, it looks very unlikely. The data shift in CME Fedwatch may not mean much for the RBI, unless it finds that high rates are really impeding GDP growth domestically. For now, that is hardly the issue.