US reports sharply lower PCE inflation for August 2024 at 2.2%

30 Sep 2024 , 11:53 AM

US PCE INFLATION SHARPLY LOWER AT 2.2% FOR AUG-24

The eagerly  awaited PCE inflation for August 2024 came in lower than expected at 2.2%; which is 30 bps lower than the previous month. In the last 9 months, the PCE Core inflation has averaged 2.74%, while the PCE Headline Inflation has averaged 2.52%. That should give some comfort to the Fed, especially since it has already embarked on an aggressive rate cutting exercise, starting off with 50 bps on September 18, 2024. However, as members of the FOMC like Michelle Bowman have pointed out repeatedly, the real challenge is the sticky core inflation, which is averaging higher than the headline inflation. With the headline PCE inflation already at 2.2%, the concerns about the last mile journey to the 2% target should recede. For the US Federal Reserve, which has already started off with a 50 bps rate cut, this sharp fall in the headline PCE inflation comes as a ratification of its stand. More importantly, PCE headline inflation has been in a narrow band, underscoring that the worst of the inflation problem in the US may be behind.

FED WAS RIGHT IN RETROSPECT ON RATE ACTION

If you look at the break-down of PCE inflation, then it was food which tapered, energy inflation which fell sharply and core inflation was actually higher. Unlike last month, this month data comes on the back of the Fed already having executed a 50 bps rate cut and having promised another 50 bps by the end of 2024. A day ahead of the PCE inflation, the US Bureau of Economic Analysis (BEA) also announced the third and final estimate of Q2GDP. At 3.0%, it was stable, but a sharp bounce from 1.6% in Q1. Ahead of the Fed meet on September 18, 2024, the Fed was confronted with two choices. It could have interpreted the bounce in GDP to 3.0% as substantially robust, so rate cuts could have been avoided or they could have been more tempered. The other choice for the Fed was to interpret this as an opportunity to not just celebrate that the hard landing was avoided, but also normalize interest rates to lower levels and make the best of this opportunity. Not surprisingly, the Fed opted for the second choice. However, in the light of the strong objections coming from the hawks, it is still an open debate as to what happens, going ahead.

FOOD, ENERGY PRICES EASE; CORE INFLATION THE ISSUE

For the month of August 2024, the sharply lower PCE inflation was led by energy inflation dipping into the negative. That is not surprising considering the sharp fall in Brent Crude prices to close to $70/bbl. In addition, food inflation also eased, but it was core inflation that actually turned in dearer. The spike in core inflation is not surprising considering that the supply chain constraints created by the pandemic had progressively eased. While the strife in the Middle East and West Asia may not have impacted oil prices, it has surely had an impact on core inflation through the plethora of trade constraints.

Month	Headline PCE Inflation	Core PCE Inflation
December 2023	2.6%	2.9%
January 2024	2.4%	2.9%
February 2024	2.5%	2.8%
March 2024	2.7%	2.8%
April 2024	2.7%	2.8%
May 2024	2.6%	2.6%
June 2024	2.5%	2.6%
July 2024	2.5%	2.6%
August 2024	2.2%	2.7%

Data Source: US Bureau of Economic Analysis (US)

If you look at the data on PCE inflation and core PCE inflation over the last 9 months; both are lower. The trend in recent months has been that, while food inflation has been flat and core inflation has edged up; it is easing energy inflation that has come as manna from heaven. For the macro picture; between December 2023 and August 2024; the headline PCE inflation has eased by 40 bps while the core PCE inflation eased by just 20 bps. At 2.2%, the headline inflation is within a stone’s throw from the eventual Fed target of 2%.

PERSONAL INCOME NARRATIVE FOR AUGUST 2024?

PCE inflation matters for two key reasons. Unlike consumer inflation, the PCE inflation comes at the end of the month and captures more data points. Secondly, PCE inflation reflects  prices from a personal consumption expenditure (PCE) perspective. That is why the US Fed relies more on PCE inflation for rate action. Here are key August 2024 data points.

• Personal income in August 2024 increased by $50.5 Billion (0.2% monthly) as per the estimates put out by the US Bureau of Economic Analysis (BEA).
• Disposable personal income (DPI); which is personal income minus personal taxes, increased $34.2 Billion (0.2%) while personal consumption expenditures (PCE) increased by $47.2 Billion (0.2%). Compared to last month, all the above figures are sharply lower.
• The increase in current-dollar personal income in August 2024 primarily reflected increases in compensation, which was partially offset by a decrease in personal income receipts on assets.
• Let us turn to the positive drivers of $47.2 Billion increase in current dollar personal consumption expenditure (PCE) for August 2024. There was an increase of $54.8 Billion in spending for services and a decrease of ($7.6) Billion spending for goods. The latter has turned around from an increase to decrease in the current month.
• Within services, the largest contributors to the spike were housing, as well as financial services and insurance. Within goods, the leading contributor to the decrease was the spending for new motor vehicles.
• Personal savings were sharply higher at $1.05 Trillion in August 2024 and the ratio of personal savings to disposable personal income spiked by 190 basis points to 4.8%.

The broad message is that the fall in inflation has been more pronounced in goods, and that has also led to a sharp spike in the personal savings of households.

BREAK-UP OF US PCE INFLATION (YOY) FOR AUGUST 2024

The US Bureau of Economic Analysis (BEA) publishes the PCE inflation on a yoy basis and on MOM basis. Let us first look at the PCE inflation on a yoy basis with granular break-up.

Break-up of PCE Inflation (YOY)	Jan-24	Feb-24	Mar-24	Apr-24	May-24	Jun-24	Jul-24	Aug-24
Headline PCE Inflation (Year on Year)	2.6	2.6	2.8	2.7	2.6	2.4	2.5	2.2
Goods	-0.5	-0.3	–	–	-0.3	-0.4	-0.2	-0.9
Durable goods	-2.2	-2.1	-1.9	-2.2	-3.0	-2.7	-2.4	-2.2
Nondurable goods	0.4	0.7	1.1	1.2	1.2	0.9	1.0	-0.2
Services	4.1	4.0	4.2	4.0	3.9	3.8	3.7	3.7
Addenda:
Core PCE excluding food and energy	3.1	2.9	3.0	2.9	2.7	2.6	2.6	2.7
Food	1.5	1.4	1.5	1.3	1.2	1.3	1.2	1.1
Energy goods and services	-4.7	-2.2	1.7	1.9	3.0	0.3	0.4	-5.0

Data Source: US Bureau of Economic Analysis (BEA)

The above table classifies yoy PCE inflation into goods and services inflation; and also breaks up inflation into food, energy, and core inflation. Here are major takeaways.

• Headline PCE inflation has shown a secular downward trend since April 2023. Between December 2023 and August 2024, the PCE inflation has fallen 40 bps to 2.2%.
• PCE inflation for goods in August 2024 was sharply lower at -0.9% compared to 0.0% in July 2024 and -0.2% in June 2024. Within goods, the durable goods showed further improvement from -2.4% to -2.2% while the inflation in non-durable goods dipped sharply by 120 bps from 1.0% to -0.2%.
• For August 2024, the services inflation was flat at 3.7%. In the last 9 months, services inflation has tapered from 4.1% to 3.7% and from a high of 5.6% in April 2023. However, in absolute terms, services inflation continues to be sticky part of the inflation story.
• Core PCE inflation yoy has shown a consistent downtrend from June 2023 till February 2024; falling 150 bps from 4.3% to 2.8%. In June and July 2024, the core inflation had been steady at 2.6%, but has bounced to 2.7% in September, showing trade pressures.
• On a yoy basis, August 2024 PCE food inflation has fallen by another 10 bps to 1.1%; and appears to have largely stabilized. Taking a longer perspective, PCE food inflation is sharply down by 360 basis points from 4.7% in June 2023.
• Energy inflation is the real factor driving PCE inflation lower. Between January 2024 and May 2024, the PCE energy inflation has spiked from -4.9% to +4.8% (a spike of 970 bps). However, the May 2024 PCE Energy inflation has been revised lower to 3.0%; but despite that the latest month inflation is a full 800 bps lower at -5.0% in August 2024.

To summarize, the future trajectory of PCE inflation would predicate on energy inflation dynamics; although it is necessary that core inflation does not spike too much.

BREAK-UP OF US PCE INFLATION (MOM) FOR AUGUST 2024

The table below captures the high frequency month-on-month (MOM) inflation published by the US Bureau of Economic Analysis (BEA), capturing short term trends.

Break-up of PCE Inflation (MOM)	Jan-24	Feb-24	Mar-24	Apr-24	May-24	Jun-24	Jul-24	Aug-24
Headline PCE Inflation (MOM)	0.4	0.3	0.3	0.3	0.0	0.1	0.2	0.1
Goods	-0.2	0.5	0.1	0.2	-0.4	-0.2	0.0	-0.2
Durable goods	0.2	0.1	0.1	-0.2	-0.8	0.0	-0.3	-0.2
Nondurable goods	-0.4	0.6	0.2	0.5	-0.1	-0.3	0.1	-0.1
Services	0.7	0.2	0.4	0.3	0.2	0.3	0.2	0.2
Addenda:
Core PCE ex-(food and energy)	0.5	0.2	0.3	0.3	0.1	0.2	0.2	0.1
Food	0.5	0.1	0.0	-0.2	0.1	0.1	0.2	0.1
Energy goods and services	-1.4	2.3	1.1	1.2	-2.1	-2.1	0.0	-0.8

Data Source: US Bureau of Economic Analysis (BEA)

Like the YOY inflation, even the MOM PCE inflation data is classified into goods and services inflation as well as food, fuel, and core inflation. Here are key takeaways.

• After being elevated in the range of 0.3% to 0.4% in the first 4 months of 2024; the MOM inflation fell back to 0.0%. In the last few months it has hovered in a low range, staying at a subdued 0.1% in August 2024.
• MOM PCE inflation for goods had dipped sharply from 0.0% to -0.2% in August 2024. The durable goods inflation went up from -0.3% to -0.2%, while non-durables inflation fell 20 bps from +0.1% to -0.1%. Services inflation MOM in August 2024 stayed static at 0.2%, and appears to have found a new normal in the last few months.
• High frequency Core PCE inflation in August 2024 was lower at 0.1%, while the food inflation (MOM) also tapered from 0.2% to 0.1%. However, it looks like energy is suppressing inflation, with MOM energy inflation falling from 0.0% to -0.8%.

Apart from the sober MOM inflation, Fed will take solace from the fact that PCE inflation has been in a range in calendar year 2024; which gives it the much needed assurance.

ROAD AHEAD VERY DOVISH, SAYS CME FEDWATCH

The CME Fedwatch, had been proved right in getting aggressive about rate cuts, after the Fed implemented a surprise 50 bps rate cut on September 18, 2024. Here is a look at the updated CME Fedwatch probabilities after PCE inflation for August 2024 was announced.

Fed Meet	200-225 #	225-250	250-275	275-300	300-325	325-350	350-375	375-400	400-425	425-450	450-475
Nov-24	Nil	Nil	Nil	Nil	Nil	Nil	Nil	Nil	Nil	53.3%	46.7%
Dec-24	Nil	Nil	Nil	Nil	Nil	Nil	Nil	28.9%	49.7%	21.3%	Nil
Jan-25	Nil	Nil	Nil	Nil	Nil	8.8%	35.3%	41.1%	14.9%	Nil	Nil
Mar-25	Nil	Nil	Nil	1.8%	14.1%	36.4%	35.8%	11.9%	Nil	Nil	Nil
May-25	Nil	Nil	1.4%	11.9%	32.4%	35.9%	16.2%	2.1%	Nil	Nil	Nil
Jun-25	Nil	0.9%	8.2%	25.2%	34.7%	23.1%	7.1%	0.7%	Nil	Nil	Nil
Jul-25	0.3%	3.5%	14.2%	28.5%	30.6%	17.5%	4.9%	0.5%	Nil	Nil	Nil
Sep-25	1.3%	6.4%	18.1%	29.1%	27.1%	14.1%	3.7%	0.4%	Nil	Nil	Nil
Oct-25	2.3%	8.1%	19.7%	28.8%	25.1%	12.5%	3.2%	0.3%	Nil	Nil	Nil
Dec-25	2.7%	8.8%	20.2%	28.6%	24.4%	12.0%	3.0%	0.3%	Nil	Nil	Nil

Data source: CME Fedwatch (# – lower probabilities consolidated)

Here is a quick dekko at how the rate cut probabilities panned out after the PCE inflation data for August 2024. There were some doubts about the extent of dovishness after the robust GDP data, but the 30 bps fall in PCE inflation has set those doubts to rest.

• With the September rate cut of 50 bps done and dusted, the focus shifts to November and December FOMC meets. The CME Fedwatch assigned a probability of 100% to 25 bps rate cuts and 53.3% probability to another 50 bps rate cut by November 2024.
• Let us look at the first milestone of December 2024. By then, another 50 bps rate cut (100 bps in all) is fait accompli. Also, there is a probability of 78.7% for an additional 75 bps rate cut. So, it could either be a total rate cut of 100 bps or 125 bps in all by end of year 2024; compared to where the rate cuts started off.
• Probabilities beyond 2024 are still evolving and will offer more clarity once the action points for year 2024 crystallize. Let us look at June 2025 milestone. The CME Fedwatch is assigning 99.3% probability for 175 bps rate cuts from the peak and 92.2% chance for 200 bps rate cuts from the peak by June 2025.
• Let us come to the final milestone of December 2025. At this point, the CME Fedwatch is estimating 96.7% probability for 200 bps of rate cuts from the peak and a high probability of 84.7% for 225 bps of rate cuts by December 2025. There is a 60.3% probability that the Fed could close year 2025 having cut rates by a full 250 bps from peak and moved to (2.75%-3.00%).

Will the Fed adhere to such an aggressive tune? The GDP growth figure had raised doubts about too much dovishness, but the PCE inflation has, probably set such doubts to rest. In terms of the immediate data points, the unemployment data for September and the minutes of the Fed meet will be the next few critical data points that the Fed will watch out for. For now, doves have outnumbered hawks, but in the fickle world of macroeconomics, optimism and pessimism can alternate quite violently.