US September inflation tapers 10 bps to 2.4% on energy deflation

11 Oct 2024 , 01:43 PM

INFLATION DATA UNDERLINES A RATHER MIXED TREND

The September 2024 consumer (CPI) inflation announced by the US Bureau of Labour Statistics (BLS) on October 10, 2024 came in 10 bps lower at 2.4%, compared to 2.5% in August 2024. It may be recollected that the headline consumer inflation in the US had fallen sharply by 40 bps between July and August 2024; which had paved the way for the aggressive 50 bps rate cut. In fact, it was a combination of two factors that triggered the 50 bps rate cut. There was the unemployment that was persistently sticky in the range of 4.2% to 4.3%, and the consumer inflation that was moving decisively towards the 2% target.

While the combination was perfect to start off on rate cuts, the latest inflation data does raise some question over the pace of rate cuts going ahead. It may be recollected that even in the September FOMC meeting, Michelle Bowman had given a dissent vote calling for restricting the rate cuts to just 25 bps instead of 50 bps. Also, the minutes reveal that the actual debate on rate cuts was a lot more split than it appeared. But the real issue is the break-up of the inflation. If you look at the 10 bps fall in headline inflation in September; there are some vast dichotomies. The fall has been almost entirely triggered by the energy deflation in September, with the energy basket deflating at -6.8%. However, food inflation was higher by 20 bps on a yoy basis, while core inflation was up 10 bps.

CAN THE FED AFFORD TO STAY AGGRESSIVELY DOVISH?

That is the million dollar question. The Fed has started off with an aggressive 50 bps rate cut. It has promised another 50 bps rate cut by end of 2024 and another 100 bps by end of 2025. That is 200 bps in all from the peak. The entire strategy is assuming a lot of front-loading of rates. However, there are two question that have arisen. Firstly, the front loading of rate cuts was based on a growth scare coming from the 4.3% unemployment figure reported for July. However, subsequent data points on GDP and unemployment have proved that it may have been more of a temporary scare. The second is the glide path of inflation. It is now being assumed that getting to 2% inflation would be a formality, but the last mile is often the hardest. Also, with sticky core inflation and higher food inflation; it remains to be seen how long the energy deflation can continue to depress the headline inflation. The Fed may have overestimated on both sides and the net result could be that the rate cuts may continue, but would be a lot more calibrated.

ENERGY DEFLATION PULLS DOWN SEPTEMBER 2024 INFLATION READING

In last few months, the tapering energy inflation had been the swing factor while core inflation was trending lower and food inflation was relatively stable. That trend had continued till August 2024. In the month of September 2024, we are seeing a situation where the energy deflation is deepening. However, with Brent crude around $80/bbl, the energy deflation may not sustain for too long. Also, in September, the food inflation is higher by 20 bps, partially due to the supply chain and trade constraints. Also, the core sector has bounced by 10 bps, indicating that the best of supply chain normalization may be done and dusted. In August 2024, energy slipped by 510 bps to +1.1% to -4.0%; and in September the energy basked has further deflated by 280 bps to -6.80%. That is where the first pressures on inflation could be visible from next month. The table below captures the monthly data on the inflation break-up for September 2024 versus August 2024.

Inflation Basket Category	Sep 2024 (YOY)	Aug 2024 (YOY)	Inflation Basket Category	Sep 2024 (YOY)	Aug 2024 (YOY)
Food Inflation	2.30%	2.10%	Core Inflation	3.30%	3.20%
Food at home	1.30%	0.90%	Commodities less food and energy	-1.00%	-1.90%
Cereals and bakery products	0.10%	-0.30%	Apparel	1.80%	0.30%
Meats, poultry, fish, and eggs	3.90%	3.20%	New vehicles	-1.30%	-1.20%
Dairy and related products	0.50%	0.40%	Used cars and trucks	-5.10%	-10.40%
Fruits and vegetables	0.70%	-0.20%	Medical care commodities	1.60%	2.00%
Non-alcoholic beverages	1.30%	1.30%	Alcoholic beverages	1.50%	1.90%
Other food at home	0.40%	0.40%	Tobacco and smoking products	8.20%	8.40%
Food away from home	3.90%	4.00%	Services less energy services	4.70%	4.90%
Full service meals and snacks	3.90%	3.80%	Shelter	4.90%	5.20%
Limited service meals	4.10%	4.30%	Rent of primary residence	4.80%	5.00%
Energy Inflation	-6.80%	-4.00%	Owners’ equivalent rent	5.20%	5.40%
Energy commodities	-15.30%	-10.10%	Medical Care Services	3.60%	3.20%
Fuel oil	-22.40%	-12.10%	Physician Services	1.50%	0.60%
Gasoline (all types)	-15.30%	-10.30%	Hospital Services	4.50%	6.10%
Energy services	3.40%	3.10%	Transport Services	8.50%	7.90%
Electricity	3.70%	3.90%	Motor vehicle Maintenance	4.90%	4.10%
Natural gas (piped)	2.00%	-0.10%	Motor vehicle insurance	16.30%	16.50%
Headline Consumer Inflation	2.40%	2.50%	Airline Fare	1.60%	-1.30%

Data Source: US Bureau of Labour Statistics

A small word of caution here. The US Federal Reserve still uses the PCE inflation as the benchmark for rate decisions. However, the consumer inflation acts as the lead indicator for PCE inflation and also sets the tone for PCE inflation. That is the reason, the consumer inflation also assumes significance. Here are key takeaways from the data.

• Let us start with food inflation. Between August 2024 and September 2024, food inflation was up by 20 bps at 2.3%. The upward thrust to food inflation cereals, meat, dairy products, fruits, and vegetables. However, the downward pressure on the food basket came from food away from home, especially limited service meals.
• Energy inflation cracked sharply by another 280 bps from -4.0% to -6.8% between August and September 2024. In the energy basket, piped natural gas inflation bounced from -0.1% to +2.0% over last month. However, the other key items in the energy basket like fuel oil and gasoline saw deepening of deflation while inflation in electricity was marginally lower by 20 bps compared to the previous month.
• Finally, let us turn to the core inflation, which was 10 bps higher at 3.3% in September 2024. The upward pressure came from apparel, used cars, physician services, airline fares, and from motor maintenance costs. However, the lowering of inflation in the core basket was visible in products like alcoholic beverages, tobacco products, rental costs, hospital services, and motor vehicle insurance.

While the headline CPI inflation still remains 40 bps above the 2% inflation target, the mix of inflation basket indicates that there could be some spike in inflation once the oil gains come to an end. That is something the Fed has to be prepared for.

SEPTEMBER 2024 MOM INFLATION FLAT

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)
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%)
Jul 2024	0.2%	0.0%	0.2%	0.2%
Aug 2024	0.1%	(0.8%)	0.3%	0.2%
Sep 2024	0.4%	(1.9%)	0.2%	0.2%

Data Source: US BLS (negative figures in brackets)

The headline MOM inflation in August 2024 was flat at 0.2%. While short term pressure on the core basket and the food basket was visible, it was more than made up by the sharp deflation in the energy basket Here is what we read from the break-up of the MOM US consumer inflation for September 2024.

1. MOM food inflation in September 2024 was sharply up 0.4%. Out of the 6 store food categories; 5 saw an increase in inflation and only 1 was flat. The inflation spike MOM was visible in meat, poultry, eggs, fruits & vegetables, other food at home, as well as dairy and related products. Only the MOM inflation for non-alcoholic beverages remained constant, showing some real pressure on the food basket in the short term.
2. The MOM Energy inflation contracted -1.9% in September 2024 over August. The gasoline index fell by -4.1% on a MOM basis. However, the electricity index increased by 0.7% as did the index of natural gas on an MOM basis.
3. The MOM Core inflation growth was 0.3% in September 2024 as compared to 0.2% in August 2024. The upward pressure comes shelter index at 0.2%, owners equivalent rent up by 0.3, while the lodging away from home fell -1.9%. Among other items in the core basket, medical care index was up 0.4%, index of physician services was up 0.9%, while the prescription drugs index contracted by -0.5%.

Overall, the high frequency MOM inflation was flat but that was largely thanks to the deflationary impact of energy basket once again.

CME FEDWATCH OPTIMISM ON RATE CUTS STARTS TO WANE

The best way to understand the shift in CME Fedwatch probabilities as a result of the inflation announcement is to compare the CME Fedwatch before and after the consumer inflation announcement. Let us first look at the CME Fedwatch probabilities after the Fed minutes, but before the CPI inflation. Even prior to the latest inflation reading, there had been some tempering of expectations that the rate cuts may not be as aggressive as originally proposed. CPI inflation has underlined that view. Here is the CME Fedwatch chart after the Fed minutes, but before the consumer inflation announcement.

Fed Meet	225-250	250-275	275-300	300-325	325-350	350-375	375-400	400-425	425-450	450-475	475-500
Nov-24	Nil	Nil	Nil	Nil	Nil	Nil	Nil	Nil	Nil	84.8%	15.2%
Dec-24	Nil	Nil	Nil	Nil	Nil	Nil	Nil	1.6%	83.4%	14.9%	Nil
Jan-25	Nil	Nil	Nil	Nil	Nil	Nil	1.2%	62.8%	32.2%	3.8%	Nil
Mar-25	Nil	Nil	Nil	Nil	Nil	1.0%	50.5%	38.3%	9.4%	0.8%	Nil
May-25	Nil	Nil	Nil	Nil	0.5%	28.1%	43.8%	22.5%	4.7%	0.3%	Nil
Jun-25	Nil	Nil	Nil	0.3%	16.6%	37.3%	31.4%	12.1%	2.2%	0.1%	Nil
Jul-25	Nil	Nil	0.1%	5.7%	23.4%	35.3%	25.1%	8.8%	1.5%	0.1%	Nil
Sep-25	Nil	Nil	2.1%	12.0%	27.6%	31.7%	19.3%	6.2%	1.0%	0.1%	Nil
Oct-25	Nil	0.5%	4.3%	15.5%	28.6%	28.9%	16.4%	5.1%	0.8%	Nil	Nil
Dec-25	0.1%	1.3%	6.8%	18.4%	28.6%	26.1%	13.9%	4.1%	0.6%	Nil	Nil

Data source: CME Fedwatch

The above table shows how the CME Fedwatch looked before the US consumer inflation reading was announced on October 10, 2024. As you can see, the markets are pegging 100 bps rate cuts by the end of 2024 and about 200 bps by the end of 2025. Let us now turn to the picture of CME Fedwatch; and how it changed after the consumer inflation for September 2024 was announced by the US BLS on October 10, 2024.

Fed Meet	225-250	250-275	275-300	300-325	325-350	350-375	375-400	400-425	425-450	450-475	475-500
Nov-24	Nil	Nil	Nil	Nil	Nil	Nil	Nil	Nil	Nil	87.9%	12.1%
Dec-24	Nil	Nil	Nil	Nil	Nil	Nil	Nil	Nil	83.1%	16.3%	0.7%
Jan-25	Nil	Nil	Nil	Nil	Nil	Nil	Nil	65.7%	30.2%	3.9%	0.1%
Mar-25	Nil	Nil	Nil	Nil	Nil	Nil	59.1%	33.8%	6.6%	0.5%	Nil
May-25	Nil	Nil	Nil	Nil	Nil	35.3%	44.0%	17.5%	3.0%	0.2%	Nil
Jun-25	Nil	Nil	Nil	Nil	21.6%	40.5%	27.8%	8.7%	1.3%	0.1%	Nil
Jul-25	Nil	Nil	Nil	7.6%	28.3%	36.0%	21.1%	6.1%	0.8%	Nil	Nil
Sep-25	Nil	Nil	2.6%	14.7%	31.0%	30.9%	15.9%	4.3%	0.6%	Nil	Nil
Oct-25	Nil	0.6%	5.3%	18.4%	31.0%	27.6%	13.3%	3.4%	0.4%	Nil	Nil
Dec-25	0.1%	1.6%	8.2%	21.2%	30.3%	24.4%	11.1%	2.8%	0.3%	Nil	Nil

(Data source: CME Fedwatch)

A quick reading of the CME Fedwatch post the inflation announcement tells you that the rate cut probabilities have not really changed much since they stabilized in a tighter range after the FOMC minutes. Here is a quick summary.

• With the September rate cut of 50 bps done for now, the focus shifts to November and December FOMC meets. The CME Fedwatch gives a probability of 87.9% to 25 bps rate cut in November 2024; with anything beyond that not on the radar.
• What about the first milestone of December 2024? By then, there is 83.0% probability of total 50 bps rate cut (100 bps in all). However, now there is a 17.0% probability that the Fed may not cross 3 rate cuts in 2024; which means just one more rate cut between November and December due to the robust growth data and a split FOMC.
• Let us turn to June 2025 milestone. The CME Fedwatch is assigning 89.9% probability for overall 150 bps rate cuts from the peak and 62.1% probability of 175 bps rate cut from the starting point of the cycle.
• Let us come to the final milestone of December 2025. At this point, the CME Fedwatch is estimating 85.8% probability for 175 bps of rate cuts from the peak and a probability of 61.4% for 200 bps of rate cuts by December 2025. So, it looks very likely that the US Fed rate could settle 175 bps to 200 bps lower by the end of December 2025; which was the picture that we got just after the FOMC minute were announced.

CME Fedwatch is getting less dovish as the growth appears to be a lot more robust and the inflation still looks vulnerable to bounce back. The CME Fedwatch is still pencilling 75 bps to 100 bps overall rate cut by end of 2024 and 175 bps to 200 bps overall by end of 2025. That brings us to the final question; what will the Fed do in the upcoming meetings?

FED IS LIKELY TO BE LESS DOVISH FROM HERE ON

The CME Fedwatch is taking the lead, showing that even the Fed could eventually get less dovish as the full impact of the jobs data, GDP growth data and the price data sinks in. Obviously, the US remains a star growth story in the advanced world and there was no reason to panic anyways. As Michelle Bowman pointed out rightly; “The 50 bps rate cut hinted at victory over inflate and desperation on economic growth; both being false signals.” Fed may have some repair work to do!