US March 2024 inflation worries the Fed at 3.5%

12 Apr 2024 , 10:05 AM

ONCE AGAIN, IT WAS ABOUT ENERGY INFLATION

For the month of March 2024, the US consumer inflation was up 30 bps at 3.5%; which is sharply higher than the consensus estimate of 3.3% to 3.4%. Let us put this entire spike in perspective. In January 2024, the US consumer inflation was to come in at 2.9%, but actually came in at 3.1%. Then in February 2024, the US consumer inflation was expected to trend higher and it actually inched up by 10 bps to 3.2%. However, March 2024 has been a sort of nasty surprise since the consumer inflation has spiked by 30 bps to 3.5%. This takes the US inflation level a good 150 bps away from the eventual target of 2.0%, so any rate cut talks will be off the table for now.

The Fed statement had already hinted at rate cuts only after July, but with the latest spike in inflation, even that sounds doubtful. It almost looks like the perspective of Michelle Bowman and Christopher Waller may eventually prevail, “When the going is so good, what is the hurry to cut rates? The pressure came from energy, which has spiked more than 700 bps in the last 2 months. For the month of March 2024, energy inflation turned around from -1.9% to +2.1%. During this period, the food inflation remained static at 2.2% while the core inflation also remained stagnant at 3.8%. Effectively, the entire pressure on inflation came from the Red Sea crisis headwinds.

WHEN GROWTH IS TOO GOOD TO BE TRUE

The real problem for the US economy is not just about rising inflation but also about the fact that GDP growth has remained robust. For the fourth quarter of 2023, the final estimate of GDP growth was upgraded by 20 bps to 3.4%. In addition, for the first quarter of 2024, the Atlanta Fed GDP estimates have been sharply upped from 2.2% to 2.8% in the previous week, indicating that most estimates had been just too conservative about the growth in the US economy. According to the Fed, such sustained growth driven by strong consumer spending is not consonant with the macros required for a rate cut. The entire scenario is boiling down to the question, “rate cuts for what”? After all, when GDP growth is already so robust, where is the need for the central bank to catalyse GDP growth.

FOOD PRICES FLAT, BUT ENERGY PLAYS SPOILSPORT IN MARCH 2024

For the latest month, food inflation and core inflation have been flat. In fact, core inflation should have been lower than 3.8%, but the energy price spike led to a rise some of the downstream business segments like transport services, motor insurance etc. The table captures monthly data on the inflation break-up for March 2024 and February 2024.

Inflation Basket Category	Mar 2024 (YOY)	Feb 2024 (YOY)	Inflation Basket Category	Mar 2024 (YOY)	Feb 2024 (YOY)
Food Inflation	2.20%	2.20%	Core Inflation	3.80%	3.80%
Food at home	1.20%	1.00%	Commodities less food and energy	-0.70%	-0.30%
·          Cereals and bakery products	0.20%	1.70%	·          Apparel	0.40%	0.00%
·          Meats, poultry, fish, and eggs	1.30%	-0.50%	·          New vehicles	-0.10%	0.40%
·          Dairy and related products	-1.90%	-1.80%	·          Used cars and trucks	-2.20%	-1.80%
·          Fruits and vegetables	2.0%	0.80%	·          Medical care commodities	2.50%	2.90%
·          Non-alcoholic beverages	2.40%	2.30%	·          Alcoholic beverages	2.40%	2.40%
·          Other food at home	1.40%	2.30%	·          Tobacco and smoking products	6.80%	7.10%
Food away from home	4.20%	4.50%	Services less energy services	5.40%	5.20%
·          Full service meals and snacks	3.20%	3.80%	Shelter	5.70%	5.70%
·          Limited service meals	5.00%	5.20%	·          Rent of primary residence	5.70%	5.80%
Energy Inflation	2.10%	-1.90%	·          Owners’ equivalent rent	5.90%	6.00%
Energy commodities	0.90%	-4.20%	Medical Care Services	2.10%	1.10%
·          Fuel oil	-3.70%	-5.40%	·          Physician Services	0.70%	0.40%
·          Gasoline (all types)	1.30%	-3.90%	·          Hospital Services	7.50%	6.10%
Energy services	3.10%	+0.50%	Transport Services	10.70%	9.90%
·          Electricity	5.00%	3.60%	·          Motor vehicle Maintenance	8.20%	6.70%
·          Natural gas (piped)	-3.20%	-8.80%	·          Motor vehicle insurance	22.20%	20.60%
Headline Consumer Inflation	3.50%	3.20%	·          Airline Fare	-7.10%	-6.10%

Data Source: US Bureau of Labour Statistics

It is true that the Fed relies more on PCE inflation for rate decisions. However, consumer inflation does form the basis for the PCE inflation and also acts as a lead indicator. The Red Sea standoff worsened in recent weeks after Iran and Israel came close to a full-fledged war. Brent Crude is trading above $90/bbl and putting pressure on US inflation.

• Let us talk about food inflation. Between February 2024 and March 2024, food inflation remained static at 2.2%, after falling 40 bps in February from 2.6% to 2.2%. The sharpest fall in prices was visible in cereals, bakery products, other food at home etc. The upward push came predominantly from fruits and vegetables.
• Energy inflation spiked 400 bps in March 2024 to +2.1%. In the last 2 months the energy inflation has spiked 670 bps and has been the driver of higher inflation in the US. The big pressure came from fuel and gasoline prices; while electricity and natural gas also spiked. The spike in energy inflation was across energy products and energy services.
• Finally, let us turn to the core inflation, which was flat at 3.8% in March 2024; after falling by 10 bps in the previous month. The items in the core basket that faced pressure were either directly or indirectly linked to higher fuel prices like transport, motor insurance, motor vehicles maintenance etc. In the core sector basket, there was some inflation relief in new vehicles, medical care, and rent.

Whether it is the apparent pressure on energy basket or the subtle pressure on core inflation, the source of the problem is rising prices of crude oil.

MOM INFLATION FLAT AT 0.4% IN MARCH 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)
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%
Mar 2024	0.1%	1.1%	0.4%	0.4%

The headline MOM inflation was flat, but there was action in the components. On an MOM basis, food inflation was up and core inflation was flat; but energy inflation was down, showing the impact of oil prices losing momentum.

1. MOM food inflation in March 2024 was higher at 0.1%. A total of 3 out of the 6 store food categories saw higher inflation. The lower inflation came from other food at home, cereals, and dairy products. The upward thrust on food inflation MOM came from meat, poultry, non-alcoholic beverages, fruits, and vegetables saw a spike in March 2024.
2. Energy index spiked 1.1% MOM in March 2024. The gasoline index spiked by 1.7% while electricity also spiked by 0.9% in the month of March 2024. The index for natural gas was unchanged on a MOM basis, while the fuel index fell by 1.3% in March 2024.
3. Core inflation growth was at 0.4% MOM in March 2024; the same level as last month. The upward pressure comes largely from shelter index at 0.4% and for rentals at 0.4%. Lodging away from home was also more expensive in March 2024, even as the index for apparel and motor vehicle insurance saw upward pressure. The index of used cars, new cars and the recreational index saw a fall in March 2024.

MARCH CPI INFLATION HAS MADE CME FEDWATCH MORE SCEPTICAL

The market impact of higher inflation was visible on the CME Fedwatch. The table below reflects the probabilities that Fed Futures traders assign to rate cuts over the next 10 Fed policies. This is the CME Fedwatch data prior to March 2024 US inflation data.

Fed Meet	300-325	325-350	350-375	375-400	400-425	425-450	450-475	475-500	500-525	525-550
May-24	Nil	Nil	Nil	Nil	Nil	Nil	Nil	Nil	4.8%	95.2%
Jun-24	Nil	Nil	Nil	Nil	Nil	Nil	Nil	2.4%	50.8%	46.8%
Jul-24	Nil	Nil	Nil	Nil	Nil	Nil	1.0%	22.4%	49.1%	27.4%
Sep-24	Nil	Nil	Nil	Nil	Nil	0.7%	15.1%	40.1%	34.8%	9.3%
Nov-24	Nil	Nil	Nil	Nil	0.2%	5.6%	23.7%	38.3%	26.0%	6.1%
Dec-24	Nil	Nil	Nil	0.1%	3.8%	17.5%	33.2%	30.3%	13.0%	2.1%
Jan-25	Nil	Nil	0.1%	1.7%	9.5%	24.1%	32.0%	23.0%	8.4%	1.2%
Mar-25	Nil	Nil	0.9%	5.8%	17.2%	28.3%	27.2%	15.3%	4.6%	0.6%
Apr-25	Nil	0.4%	2.7%	10.1%	21.3%	27.9%	22.8%	11.3%	3.1%	0.4%
Jun-25	0.2%	1.5%	6.2%	15.5%	24.5%	25.4%	17.3%	7.4%	1.8%	0.2%

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 to 75 bps rate cut by the end of 2024 with a 50% probability for both outcomes. For FY25, the expectation up to June 2024 was rate cuts to the tune of about 100 bps by mid-2025. This is in contrast to initial aggression shown by the CME Fedwatch. But, how did the probabilities change after the inflation data was announced by the 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
May-24	Nil	Nil	Nil	Nil	Nil	Nil	Nil	Nil	4.1%	95.9%
Jun-24	Nil	Nil	Nil	Nil	Nil	Nil	Nil	0.7%	19.1%	80.2%
Jul-24	Nil	Nil	Nil	Nil	Nil	Nil	0.2%	6.4%	38.1%	55.3%
Sep-24	Nil	Nil	Nil	Nil	Nil	0.1%	3.0%	20.7%	45.8%	30.4%
Nov-24	Nil	Nil	Nil	Nil	Nil	0.8%	7.4%	26.9%	41.9%	23.0%
Dec-24	Nil	Nil	Nil	Nil	0.4%	4.4%	17.8%	34.6%	31.8%	11.0%
Jan-25	Nil	Nil	Nil	0.2%	1.8%	8.9%	23.6%	33.7%	24.7%	7.1%
Mar-25	Nil	Nil	0.1%	0.9%	5.1%	15.7%	28.2%	29.5%	16.6%	3.9%
Apr-25	Nil	Nil	0.3%	2.1%	8.0%	19.2%	28.7%	26.0%	13.0%	2.7%
Jun-25	Nil	0.1%	4.0%	4.6%	12.7%	23.2%	27.6%	20.5%	8.6%	1.6%

Data source: CME Fedwatch

The higher US consumer inflation has made the CME Fedwatch more dovish. Now, the CME Fedwatch is assigning about 76% probability to just 2 rate cuts in the year 2024 and a probability of just 24% to 3 rate cuts by end of 2024. Also, there is a lot of dichotomy about he start of the rate cuts, post the election data. For instance, prior to the inflation announcement, there was just 9.3% probability that rates would stay static till September 2024. Now that probability has gone up to 30.4%. Similarly, prior to the inflation data announcement, the street assigned a 74% probability for rate cuts commencing in July 2024. Post the inflation data, that probability has come down to just 45%. Clearly, the CME Fedwatch is a lot less enthusiastic about the pace of rate cuts after the inflation data.

ARE FED RATE CUTS OFF THE TABLE; AND WHAT WILL THE RBI DO?

Ahead of the inflation data, there was a high probability that rate cuts would commence from July. That is not the case any longer and even September looks doubtful now. With inflation having spiked by 40 bps in 2 months and the Red Sea crisis not showing signs of abating, the Fed would prefer to err on the side of caution. Now, even a July rate cuts could only happen if the inflation recedes sharply in the next 2-3 months. The Fed is likely to move cautiously. While PCE inflation will be the real driving factor, the concern is that CPI inflation is now a full 150 bps away from the eventual target of 2%.

For the RBI, the US consumer inflation will remain a key input as it grapples with sticky inflation in India. The March reading is expected to come out on Friday, but it is expected to hover around 5%. Food inflation continues to be a challenge for the RBI. The RBI is likely to remain on wait and watch mode. With US itself contending with the ghost of inflation, the RBI would prefer to sit aside till the elections are done, a new government is formed at the centre, and the full budget is presented. That would be around July; but it should coincide with the Fed also starting to consider rate cuts.