US June inflation tapers 30 bps to 3.0%; as energy inflation eases

18 Jul 2024 , 09:50 AM

IS THE US CLOSER TO A RATE CUT THAN WE BELIEVE?

The global markets appear to be almost celebrating as if the Fed has already cut the repo rates. While the Fed has guided for one rate cut in 2024, the CME Fedwatch is already pegging a high probability of 2 rate cuts in 2024 and another 4 rate cuts in 2025. Gold has started rallying and is now inching closer to $2,459/oz. The trigger this time is an imminent rate cut by the Fed, which will reduce the opportunity cost of holding gold by investors and traders. The markets may not be entirely off the market. While the Fed still relies on PCE (personal consumption expenditure) based inflation its rate decision, the consumer inflation continues to be the key lead indicator. For June 2024, the yoy consumer inflation has dipped by 30 bps to 3.0% while the high frequency MOM consumer inflation even dipped into negative zone. The trigger for the sharp fall in inflation was the energy inflation coming down sharply from 3.7% to 1.0% in June 2024.

In his testimony before the Congress, Jerome Powell underlined that it was hard to commit on a firm date when rate cuts would start. However, he also affirmed that the risk of GDP growth and labour data being out of sync with 2% inflation target had reduced substantially. That opened the doors for rate cuts in the September FOMC meet, if not in the July 31 FOMC meet. While the Fed has been non-committal about the trajectory of rates and the timelines for rate cuts, the markets appear confident that the Fed would cut rates sooner, rather than later. Next week, we will have the final estimate for Q1GDP growth and the PCE inflation for June. If these are favourable, then September 2024 rate cut is very likely.

ENERGY INFLATION FALLS SHARPLY IN JUNE 2024

It began with the Red Sea crisis and since then global oil prices have been on a boil. The US oil output has been at record levels, but the US demand has been growing at a frenetic pace. The result has been that week-after-week, the US is seeing persistent drawdowns on its Crude Oil Reserves. Even in the latest week, the API estimates suggest that the drawdown of reserves was much larger than anticipated. For the month of June 2024, the food inflation was higher by 10 bps while the core inflation was down 10 bps. However, the energy inflation made the real difference falling 270 bps from 3.7% to 1.0%. Within the energy basket, there was a sharp fall in fuel oil, gasoline, and electricity; while piped natural gas faced higher inflation. The table below captures the monthly data on the inflation break-up for June 2024 versus May 2024.

Inflation Basket Category	Jun 2024 (YOY)	May 2024 (YOY)	Inflation Basket Category	Jun 2024 (YOY)	May 2024 (YOY)
Food Inflation	2.20%	2.10%	Core Inflation	3.30%	3.40%
Food at home	1.10%	1.00%	Commodities less food and energy	-1.80%	-1.70%
·          Cereals and bakery products	0.50%	0.70%	·          Apparel	0.80%	0.80%
·          Meats, poultry, fish, and eggs	2.60%	2.40%	·          New vehicles	-0.90%	-0.80%
·          Dairy and related products	-0.10%	-1.00%	·          Used cars and trucks	-10.10%	-9.30%
·          Fruits and vegetables	-0.50%	0.60%	·          Medical care commodities	3.10%	3.10%
·          Non-alcoholic beverages	1.50%	1.30%	·          Alcoholic beverages	1.80%	1.70%
·          Other food at home	1.60%	1.00%	·          Tobacco and smoking products	8.20%	7.80%
Food away from home	4.10%	4.00%	Services less energy services	5.10%	5.30%
·          Full service meals and snacks	3.90%	3.50%	Shelter	5.20%	5.40%
·          Limited service meals	4.30%	4.50%	·          Rent of primary residence	5.10%	5.30%
Energy Inflation	1.00%	3.70%	·          Owners’ equivalent rent	5.40%	5.70%
Energy commodities	-2.20%	2.20%	Medical Care Services	3.30%	3.10%
·          Fuel oil	0.80%	3.60%	·          Physician Services	0.80%	1.40%
·          Gasoline (all types)	-2.50%	2.20%	·          Hospital Services	6.90%	7.20%
Energy services	4.30%	4.70%	Transport Services	9.40%	10.50%
·          Electricity	4.40%	5.90%	·          Motor vehicle Maintenance	6.00%	7.20%
·          Natural gas (piped)	3.70%	-0.20%	·          Motor vehicle insurance	19.50%	20.30%
Headline Consumer Inflation	3.00%	3.30%	·          Airline Fare	-5.10%	-5.90%

Data Source: US Bureau of Labour Statistics

There is a small clarification here. The US Federal Reserve still relies more on PCE inflation for rate decisions; than on CPI inflation. The reasons are not far to seek. PCE inflation is based on personal consumption expenditure and factors in consumption and price trends. However, CPI inflation sets the basis for PCE inflation and also acts as a lead indicator. That is because CPI inflation is announced in the US before the middle of the month while the PCE inflation is announced towards the end of the month. Here is a quick dekko.

• Let us start with food inflation. Between May 2024 and June 2024, food inflation increased by 10 bps to 2.2%. The spike came from high protein products like meat, poultry, and dairy products as well as non-alcoholic beverages. On the other hand, the prices of fruits and vegetables as well as cereals were lower compared to May 2024. The price spike continued to be visible in high protein food products in June 2024 too.
• Energy inflation fell sharply by 270 bps in June 2024 to 1.0%. There was a sharp fall in the key components like fuel, gasoline, and electricity. However, piped natural gas prices continued to spike in June 2024, compared to the levels in May.
• Finally, let us turn to the core inflation, which was lower by 100 bps at 3.3% in June 2024. The upward pressure came from alcoholic beverages, tobacco products and airline fares. However, there were also items that exerted downward pressure on the core inflation, which included used cars, rentals, physician services, motor vehicles maintenance and motor insurance.

While the headline CPI inflation still remains 100 bps above the 2% inflation target, what is gratifying is that energy inflation has shown a sharp downtrend in June 2024.

JUNE 2024 MOM INFLATION IN CONTRACTION MODE

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)
Jan 2024	0.4%	(0.9%)	0.4%	0.3%
Feb 2024	0.0%	2.3%	0.4%	0.4%
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%)

Data Source: US BLS (negative figures in brackets)

The headline MOM inflation was lower, but there was contrasting action in the components. On an MOM basis, food inflation was up and core inflation was up; but energy inflation once again fell sharply MOM; taking the headline MOM inflation into negative zone.

1. MOM food inflation in May 2024 was higher for the second successive month at 0.2%. Out of the 6 store food categories; 4 saw an increase in inflation and 2 saw fall in inflation. The higher inflation came from butter & margarine, dairy products, meat/poultry, and non-alcoholic beverages. The downward thrust to food inflation MOM came from fruits & vegetables and cereals / bakery products in June 2024.
2. Energy index again fell -2.0% MOM in June 2024. The gasoline index fell by -3.8% while fuel oil fell by 2.4% and electricity fell by 0.7% in June 2024. The index for natural gas increased by 0.2% on a MOM basis in June 2024.
3. Core inflation growth was 0.1% MOM in June 2024. The upward pressure comes largely from shelter, rentals, medical care services and physician services. The downward pressure MOM came from airline fares, used cars & trucks as well as telecommunication services.

Overall, the high frequency fall in oil prices was largely instrumental in bringing the MOM CPI inflation in June 2024 into negative zone for the first time in last 6 months.

CME FEDWATCH OPTIMISTIC ABOUT RAPID RATE CUTS

The 30 bps fall in headline inflation has certainly made the CME Fedwatch more dovish and optimistic. While the Fed is still sticking to one rate cut in 2024, the CME Fedwatch is already pencilling in 2 rate cuts in 2024 with a high probability. Here is how the CME Fedwatch looked like before the CPI inflation data was announced.

Fed Meet	325-350	350-375	375-400	400-425	425-450	450-475	475-500	500-525	525-550	550-575
Jul-24	Nil	Nil	Nil	Nil	Nil	Nil	Nil	7.8%	92.2%	Nil
Sep-24	Nil	Nil	Nil	Nil	Nil	Nil	5.9%	72.0%	22.1%	Nil
Nov-24	Nil	Nil	Nil	Nil	Nil	2.5%	33.8%	50.9%	12.8%	Nil
Dec-24	Nil	Nil	Nil	Nil	2.0%	27.3%	47.3%	20.8%	2.7%	Nil
Jan-25	Nil	Nil	Nil	1.4%	19.3%	41.0%	29.1%	8.3%	0.8%	Nil
Mar-25	Nil	Nil	1.0%	14.0%	34.6%	32.6%	14.5%	3.1%	0.2%	Nil
Apr-25	Nil	0.5%	7.4%	24.2%	33.6%	23.6%	8.8%	1.7%	0.1%	Nil
Jun-25	0.3%	5.0%	18.4%	30.4%	27.1%	13.9%	4.1%	0.7%	Nil	Nil
Jul-25	2.2%	10.2%	23.0%	29.1%	22.0%	10.2%	2.8%	0.4%	Nil	Nil
Sep-25	10.1%	20.1%	27.7%	23.6%	12.9%	4.5%	1.0%	0.1%	Nil	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 50 bps rate cut by the end of 2024 with another 50 bps happening by middle of 2025. CME Fedwatch was pegging interest rates in the range of 4.25% to 4.50% by middle of 2025. Here is how CME Fedwatch changed post-inflation.

Fed Meet	300-325	325-350	350-375	375-400	400-425	425-450	450-475	475-500	500-525	525-550
Jul-24	Nil	Nil	Nil	Nil	Nil	Nil	Nil	Nil	6.2%	93.8%
Sep-24	Nil	Nil	Nil	Nil	Nil	Nil	Nil	6.0%	90.3%	3.8%
Nov-24	Nil	Nil	Nil	Nil	Nil	Nil	3.6%	56.3%	38.6%	1.5%
Dec-24	Nil	Nil	Nil	Nil	Nil	3.2%	50.6%	40.5%	5.5%	0.2%
Jan-25	Nil	Nil	Nil	Nil	2.3%	37.8%	43.2%	14.9%	1.6%	Nil
Mar-25	Nil	Nil	Nil	1.9%	30.8%	42.2%	20.6%	4.3%	0.4%	Nil
Apr-25	Nil	Nil	1.1%	18.6%	37.4%	29.7%	11.1%	2.0%	0.2%	Nil
Jun-25	Nil	0.8%	13.5%	31.9%	31.9%	16.5%	4.6%	0.7%	Nil	Nil
Jul-25	0.3%	6.5%	21.8%	31.9%	25.0%	11.2%	2.9%	0.4%	Nil	Nil
Sep-25	5.9%	19.6%	30.5%	16.0%	13.1%	4.0%	0.8%	0.1%	Nil	Nil

Data source: CME Fedwatch

There are two shifts that are visible in the CME Fedwatch numbers post inflation announcement for June 2024.

• In the light of the 30 bps fall in US consumer inflation, let us first focus on rate cut probability in 2024. Currently, the CME Fedwatch has assigned a 96.2% probability of the first rate cut happening in September. This was just 78% last week. For now, July rate cut has a probability of just about 6.2%; and with just about 10 days to go, that does look unlikely. However, by December 2024, the CME Fedwatch is pencilling in an incredibly high probability of 94.3% that 2 rate cuts could happen this year. That is in contrast to the Fed guidance of just one rate cuts in the current calendar year.
• Let us now turn to the CME Fedwatch expectations stack for 2025? By July 2025, the CME Fedwatch is factoring in 96.7% probability of 4 rate cuts, sharply higher than 86.6% probability as of last week. In addition, the CME Fedwatch is also assigning a probability of 95.1% probability of 5 rate cuts by September 2025. These probabilities will evolve more realistically once the Fed embarks on its first rate cut this year.

The quick takeaway is that the probability of rate cuts and the intensity of rate cuts have gone up sharply after the 30 bps fall in the US consumer inflation in June 2024. However, there is still many a slip between the cup and the lip; so, the first rate cut in September could change the entire confidence levels of the CME Fedwatch. We have to wait and watch!

ARE THE MARKETS JUSTIFIED IN EXPECTING 2 RATE CUTS IN 2024?

In the last Fed policy statement, it comes out clearly that the Federal Reserve wants the markets to only pencil one rate cut in 2024. Of course, the Fed hastened to clarify that even that is subject to inflation coming under control. However, the reality could be different and the US is likely to be under pressure to undertake pre-emptive rate cuts if the pressure on growth continues. For example, the GDP growth for Q1 has been sharply lower at 1.3% and the final estimate of Q1 GDP growth will be out in the coming week, before the Fed meet.

In the last two months, while consumption and labour markets are still robust, the GDP growth numbers appear to be under pressure. Even the labour demand supply situation looks a lot more in balance now. Pre-emptive rate cuts may be the answer to this situation; and that is exactly what the CME Fedwatch appears to be betting on.