US May-24 inflation lower at 3.3%; as energy inflation pinches

14 Jun 2024 , 11:46 AM

WHEN IN DOUBT; BELIEVE THE HAWKS

There is a popular belief that when it comes to monetary policy, regulators always prefer to play it safe. In the last few months, there has been serious dichotomy between the noises coming from the Fed chair and the other members of the Fed. For instance, Jerome Powell has himself been trying to talk the markets into a sense of smugness. He had assured the markets about 3 rate cuts in 2024. Even in the previous policy statement, the Fed had not yet changed its guidance on number of rate cuts, although the CME Fedwatch was also pencilling in 2 rate cuts with just 45% probability. However, within the system, there have bene hawkish voices like Bostic, Cook and Michelle Bowman who were consistently warning the markets that rate cuts were unlikely in 2024 and that even rate hikes were possible.

In the last few weeks, no less a person that Neil Kashkari of the US Fed had also shifted to the hawkish camp. His opinion was that the last mile inflation in the US was proving to be much stickier than expected and that was unlikely to permit rate cuts in 2024. Like some of the other hawks, Kashkari also did not rule out rate hikes if high inflation persisted. The view of Neil Kashkari was important as he has a background in investment banking in one of the bluest of investment banks, Goldman Sachs. Kashkari was known to be a dove and the markets were quite surprised when he became a convert to the hawk camp. It only underlined that the problem of inflation in the US was not just sticky, but the last mile was getting tougher to resolve. The energy price pressures are only making the job tougher.

Finally, there is a clarity on the subject of rate trajectory. The latest policy statement presented by the Fed brings a lot more clarity on the subject. It has virtually ruled out more than 1 rate cut in 2024 and further rate cuts will only be taken up in 2025. The Fed has also underlined that the first rate cut may only happen around September and after that the Fed may choose to wait and watch till the data is conducive for further rate cuts. For now, the idea of any pre-emptive rate cuts in the July meeting is almost ruled out. Even the latest US consumer inflation data at 3.3% indicates that while the headline inflation has been trending lower, food and core inflation may have done their bit. It is back to the age-old Fed wisdom that, “when in doubt, just believe the hawks.” That is a safe thing to do!

CORE INFLATION LOWER, ENERGY PRICES SHARPLY HIGHER IN MAY 2024

For the month of May 2024, food inflation was marginally lower by 10 bps at 2.1%, while core inflation has tapered another 20 bps to 3.4%. The pressure continues to come from energy inflation, which spiked from 2.1% in March 2024 to 2.6% in April 2024; and further up to 3.7% in May 2024. However, with the OPEC also planning to hike supply by the end of this year, the pressures of oil prices on inflation may be limited. The table captures monthly data on the inflation break-up for May 2024 and April 2024.

Inflation Basket Category	May 2024 (YOY)	Apr 2024 (YOY)	Inflation Basket Category	May 2024 (YOY)	Apr 2024 (YOY)
Food Inflation	2.10%	2.20%	Core Inflation	3.40%	3.60%
Food at home	1.00%	1.10%	Commodities less food and energy	-1.70%	-1.30%
·          Cereals and bakery products	0.70%	0.60%	·          Apparel	0.80%	1.30%
·          Meats, poultry, fish, and eggs	2.40%	1.00%	·          New vehicles	-0.80%	-0.40%
·          Dairy and related products	-1.00%	-1.30%	·          Used cars and trucks	-9.30%	-6.90%
·          Fruits and vegetables	0.60%	1.70%	·          Medical care commodities	3.10%	2.50%
·          Non-alcoholic beverages	1.30%	2.30%	·          Alcoholic beverages	1.70%	2.00%
·          Other food at home	1.00%	1.40%	·          Tobacco and smoking products	7.80%	6.70%
Food away from home	4.00%	4.10%	Services less energy services	5.30%	5.30%
·          Full service meals and snacks	3.50%	3.40%	Shelter	5.40%	5.50%
·          Limited service meals	4.50%	4.80%	·          Rent of primary residence	5.30%	5.40%
Energy Inflation	3.70%	2.60%	·          Owners’ equivalent rent	5.70%	5.80%
Energy commodities	2.20%	1.10%	Medical Care Services	3.10%	2.70%
·          Fuel oil	3.60%	–0.80%	·          Physician Services	1.40%	0.90%
·          Gasoline (all types)	2.20%	1.20%	·          Hospital Services	7.20%	7.70%
Energy services	4.70%	3.60%	Transport Services	10.50%	11.20%
·          Electricity	5.90%	5.10%	·          Motor vehicle Maintenance	7.20%	7.60%
·          Natural gas (piped)	-0.20%	-1.90%	·          Motor vehicle insurance	20.30%	22.60%
Headline Consumer Inflation	3.30%	3.40%	·          Airline Fare	-5.90%	-5.80%

Data Source: US Bureau of Labour Statistics

Here, there is one point to note. The US Federal Reserve still relies more on PCE inflation for rate decisions; than on CPI inflation. PCE inflation is based on personal consumption expenditure and announced towards the end of the month. However, CPI inflation sets the basis for PCE inflation and also acts as a lead indicator. While Brent prices are hovering lower around $80/bbl, the situation in West Asia remains a question mark as Israel continues its war with the Hamas in Gaza. That is likely to keep West Asia and the Middle East on the boil. Let us not look at the break up of yoy US inflation on a granular basis.

• Let us start with food inflation. Between April 2024 and May 2024, food inflation tapered by 10 bps to 2.1%. The sharpest fall in prices was visible in fruits & vegetables, non-alcoholic beverages, and food at home. The price spike was visible on a yoy basis in high protein food products like meat, eggs, fish, and poultry; as well as dairy products.
• Energy inflation spiked sharply by 110 bps in May to 3.7%. While the oil impact is peaking out, the latest month still shows oil price pressure on inflation. More importantly, this week also saw a sharp spike in energy commodities like fuel oil and gasoline as well as in energy services like electricity and natural gas supply.
• Finally, let us turn to the core inflation, which was lower by 20 bps at 3.4% in May 2024. The upward pressure came from tobacco products and medical care facilities. However, there were also items that exerted downward pressure on the core inflation, which included apparel, new vehicles, used cars, motor vehicle maintenance, motor insurance and airline fares.

While the headline CPI inflation still remains 130 bps above the 2% inflation target, what is disconcerting is the sharp spike in energy inflation, after a brief respite.

MOM INFLATION TAPERS TO 0.0% IN MAY 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)
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%
Apr 2024	0.0%	1.1%	0.3%	0.3%
May 2024	0.1%	-2.0%	0.2%	0.0%

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 down; but energy inflation fell sharply MOM taking the headline inflation to 0.0% on an MOM basis.

1. MOM food inflation in May 2024 was higher at 0.1%. Out of the 6 store food categories; 2 saw an increase in inflation, 2 saw fall, while 2 items showed no change in inflation. The lower inflation came from dairy products and non-alcoholic beverages. The upward thrust on food inflation MOM came from meat, poultry, fish, eggs, cereals, and bakery products in May 2024.
2. Energy index fell -2.0% MOM in May 2024. The gasoline index fell by -3.6% while fuel oil also fell by 0.4% in the month of May 2024. The index for natural gas was up 0.2% on a MOM basis, while electricity fell by –5.9% in May 2024.
3. Core inflation growth was at 0.2% MOM in May 2024. The upward pressure comes largely from shelter index and rent at 0.4% each. Medical care was also higher while the fall was triggered by used cars and trucks and education services.

Overall, the high frequency fall in oil prices was largely instrumental in bringing the MOM CPI inflation in May 2024 to 0.0% levels.

MAY 2024 CPI INFLATION MAKES CME FEDWATCH CAUTIOUS

The 10 bps fall in headline inflation should have ideally made the CME Fedwatch more dovish and optimistic. However, that has not happened, since on the same day, the Fed policy statement was also announced ruling out more than one rate cut in 2024. Here is how the CME Fedwatch looked like before the 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
Jun-24	Nil	Nil	Nil	Nil	Nil	Nil	Nil	2.24%	97.8%	Nil
Jul-24	Nil	Nil	Nil	Nil	Nil	Nil	0.1%	8.1%	91.8%	Nil
Sep-24	Nil	Nil	Nil	Nil	Nil	0.1%	3.8%	46.6%	49.5%	Nil
Nov-24	Nil	Nil	Nil	Nil	Nil	1.1%	15.9%	47.4%	35.6%	Nil
Dec-24	Nil	Nil	Nil	Nil	0.7%	10.2%	35.3%	40.1%	13.7%	Nil
Jan-25	Nil	Nil	Nil	0.3%	4.9%	21.3%	37.4%	28.4%	7.6%	Nil
Mar-25	Nil	Nil	0.2%	2.7%	13.6%	29.8%	32.7%	17.4%	3.6%	Nil
Apr-25	Nil	0.1%	1.1%	6.5%	19.3%	30.8%	27.3%	12.6%	2.3%	Nil
Jun-25	Nil	0.6%	4.0%	13.4%	25.5%	28.9%	19.4%	7.1%	1.1%	Nil
Jul-25	0.3%	1.9%	7.6%	18.0%	26.8%	25.3%	14.7%	4.8%	0.7%	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. In short, the CME Fedwatch was pegging the interest rates in the range of 4.25% to 4.50% by the middle of 2025. Did these probabilities really change after the inflation data for May 2024 was announced by the Bureau of Labour Statistics (BLS)? The table below captures probabilities post the US inflation announcement.

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	10.3%	89.7%
Sep-24	Nil	Nil	Nil	Nil	Nil	Nil	Nil	6.6%	61.1%	32.3%
Nov-24	Nil	Nil	Nil	Nil	Nil	Nil	2.6%	27.9%	49.8%	19.7%
Dec-24	Nil	Nil	Nil	Nil	Nil	2.2%	22.2%	44.9%	26.5%	4.5%
Jan-25	Nil	Nil	Nil	Nil	1.3%	15.4%	36.6%	32.9%	12.1%	1.5%
Mar-25	Nil	Nil	Nil	0.9%	10.9%	30.0%	34.1%	18.7%	4.9%	0.5%
Apr-25	Nil	Nil	0.4%	5.7%	20.0%	32.0%	26.8%	12.1%	2.8%	0.3%
Jun-25	Nil	0.3%	3.8%	14.8%	27.6%	28.7%	17.5%	3.2%	1.2%	0.1%
Jul-25	0.1%	1.7%	8.2%	20.0%	28.0%	24.1%	12.9%	4.2%	0.7%	0.1%

Data source: CME Fedwatch

There are two shifts that are visible in the CME Fedwatch numbers before and after the inflation and policy statement. Firstly, the probabilities in the current year have moved right, which means they expect this year to be predominantly hawkish. However, the rate cuts are expected to be more aggressive in 2025 as the Fed is likely to back end more of its rate cuts in 2025. What about end-2024 and mid-2025 probabilities?

As of date, there is about 68% probability that the first rate cut will happen in September, which is quite high. However, the CME Fedwatch is still assigning a 69% probability that the Fed will cut rates twice by December 2024. That means; despite the “only 1 rate cut in 2024” statement by the Fed, the CME Fedwatch has not changed its stance substantially.

What about the expected situation in mid-July 2025? There is an 82% probability of 4 rate cuts by July 2025, and a 58% probability of 5 rate cuts by July 2025. In short, the moral of the story is that the CME Fedwatch expects that even if the Fed is slightly cautious on rate cuts in 2024, it is likely to be a lot more aggressive in 2025.

SHOULD MARKETS RECONCILE TO JUST ONE RATE CUT IN 2024?

In the Fed policy statement, it comes out clearly that the Federal Reserve wants the markets to only pencil one rate cut in 2024; and 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. In the last two months, while consumption and labour market is still robust, the GDP growth numbers appear to be under pressure. Rate cuts, possibly pre-emptive, may be the only answer to this situation; and that is exactly what the CME Fedwatch appears to be betting on, despite sticky consumer inflation.