Jun-24 PCE inflation tapers to 2.5%, as energy prices ease

29 Jul 2024 , 11:23 AM

A DAY AFTER ROBUST GDP; PCE INFLATION TAPERS BY 10 BPS

The PCE inflation always had a special place in the US macroeconomic calculations. For the US Federal Reserve, the trend in the PCE inflation is still the factor that determines whether the Fed should cut rates or note. That indicator has been goading the Fed to cut rates and the clamour is gradually getting louder. If you look at the PCE inflation data since January 2024, it has not really fallen, but then it has been in a very narrow range of 30 bps between 2.4% and 2.7%. That is, perhaps, the best indication that the PCE inflation in the US is decisively moving towards the 2% mark. The signals of easing inflation were picked up by the consumer inflation announced in the middle of July, but PCE data provides the much-needed affirmation.

More importantly, the PCE inflation comes just one day after the first advance estimate of Q2-GDP in the US bounced from 1.4% to 2.8%. Now, there are two ways to look at it. One approach is to say that if the GDP is already robust, then why do we really need rate cuts? But, that argument can be buttressed by the fact that consumption spending is  under pressure. The second argument is that the hard landing has been avoided, so it is time to normalize interest rates to lower levels. That is the argument that is likely to stick. The CME Fedwatch is already assigning a 100% probability to the first rate cut of 25 bps happening in September and a very high probability of 98% to two rate cuts happening in 2024. We will get greater clarity on this subject after the impact of the first rate cut is evaluated.

CORE INFLATION FLAT; BUT ENERGY EASES HEADLINE PCE INFLATION

In the last 1 year, the big story has been the core PCE inflation (ex-energy & food) leading the headline inflation lower in the US. That is not surprising as the supply chain constraints created by the pandemic eased. That story appears to have played out. In the last few months, headline inflation had been impacted by energy inflation while the core inflation had been marginally impacted by the Red Sea crisis. Here is the comparative trajectory.

Month	Headline PCE Inflation	Core PCE Inflation
October 2023	2.9%	3.4%
November  2023	2.7%	3.2%
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%

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 decisively lower. The trend in recent months has been that, while core inflation and food inflation have been volatile, easing energy inflation has helped the headline PCE inflation to normalize. Between October 2023 and June 2024; the headline PCE inflation has eased by 40 bps while the core PCE inflation eased by 80 bps. Had energy been supportive in the last few months, then the headline inflation could have been closer to the target 2% mark; but that would be more of wishful thinking.

PERSONAL INCOME NARRATIVE FOR JUNE 2024?

PCE inflation is relevant in 2 ways. Firstly, being announced at the end of the month, it includes more data points than consumer inflation. Secondly, PCE inflation reflects  prices from a personal consumption expenditure (PCE) perspective. That is why the US Fed relies more on PCE inflation as the benchmark for rate action. Here are key May 2024 data points.

• Personal income in June 2024 increased by $50.4 Billion (0.2% monthly) as per the estimates put out by the US Bureau of Economic Analysis (BEA).
• Disposable personal income (DPI), personal income minus personal taxes, increased $37.7 Billion (0.2%) while personal consumption expenditures (PCE) increased by $57.6 Billion (0.3%). Compared to last month, the DPI is lower but PCE is higher.
• The increase in current-dollar personal income in June 2024 primarily reflected increases in compensation and personal current transfer receipts on assets.
• Let us turn to the positive drivers of $57.6 Billion increase in personal consumption expenditure for June 2024. There was an increase of $53.1 Billion in spending for services and an increase of $4.5 Billion spending for goods.
• Within services, the largest contributors to the spike were international travel, housing, and spending on consumption of utilities.
• Within goods, the leading contributor to the increase were spending on non-durable goods (led by pharmaceuticals and other medicinal products), recreational goods and information processing equipment. This was partially offset by decrease in motor vehicles & parts, and gasoline and other energy goods.
• Personal savings were lower at $703.0 Billion in June 2024 and the ratio of personal savings to disposable personal income fell by 50 bps to 3.4%.

The broad message is that the US people are getting a little more cautious about spending and that is a good sign as it could now rein in the consumption driven inflation.

BREAK-UP OF US PCE INFLATION (YOY) FOR JUNE 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)	Nov-23	Dec-23	Jan-24	Feb-24	Mar-24	Apr-24	May-24	Jun-24
Headline PCE Inflation (Year on Year)	2.7	2.6	2.5	2.5	2.7	2.7	2.6	2.5
Goods	-0.1	0.2	-0.5	-0.2	0.1	0.1	-0.1	-0.2
Durable goods	-2.1	-2.3	-2.4	-2.0	-1.9	-2.2	-3.2	-2.9
Nondurable goods	1.0	1.6	0.5	0.8	1.3	1.4	1.6	1.2
Services	4.1	3.9	4.0	3.9	4.0	4.0	4.0	3.9
Addenda:
Core PCE excluding food and energy	3.2	2.9	2.9	2.8	2.8	2.8	2.6	2.6
Food	1.7	1.4	1.4	1.3	1.5	1.3	1.2	1.4
Energy goods and services	-5.0	-1.7	-4.9	-2.3	2.6	3.0	4.8	2.0

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 October 2023 and June 2024, the PCE inflation has fallen 40 bps to 2.5%.
• PCE inflation for goods went deeper into negative at -0.2% in the month of June 2024, compared to -0.1% in May 2024. Within goods, the durable goods showed some improvement from -3.2% to -2.9% while the inflation in non-durable goods tapered by 40 bps from 1.6% to 1.2%. This can be attributed to relatively normalization of delivery delays caused by the Red Sea crisis.
• For May 2024, the services inflation tapered by 10 bps from 4.0% to 3.9%. However, the May 2024 services inflation had been upped by 10 bps, so net impact is Nil. Incidentally, the services inflation is down a full 170 bps from a high of 5.6% in April 2023.
• Core PCE inflation yoy has shown a consistent downtrend from June 2023 till February 2024; falling 150 bps from 4.3% to 2.8%. After stagnating for 2 months; core PCE inflation fell to 2.6% in May 2024, where it stays in June 2024 also.
• On a yoy basis, PCE food inflation is 20 bps higher at 1.4%, but is sharply down by 330 basis points from 4.7% in June 2023. In calendar 2024, March and June were the two months that saw a spike in food inflation.
• Energy inflation continues to be the crux of the inflation problem in the US, largely on account of the Red Sea crisis keeping oil prices buoyant. Between January 2024 and May 2024, the PCE energy inflation has spiked from -4.9% to +4.8% (a spike of 970 bps). However, in June 2024, the energy inflation has eased by 280 bps to 2.0% as the fears of slowing Chinese demand has taken its toll on oil prices.

To summarize, the future trajectory of PCE inflation would largely predicate on energy inflation dynamics; as the other components have largely stabilized.

BREAK-UP OF US PCE INFLATION (MOM) FOR JUNE 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)	Nov-23	Dec-23	Jan-24	Feb-24	Mar-24	Apr-24	May-24	Jun-24
Headline PCE Inflation (MOM)	0.0	0.1	0.4	0.3	0.3	0.3	0.0	0.1
Goods	-0.6	-0.2	-0.2	0.5	0.1	0.2	-0.4	-0.2
Durable goods	-0.5	-0.5	0.2	0.2	0.1	-0.2	-0.8	0.0
Nondurable goods	-0.6	-0.1	-0.4	0.7	0.2	0.5	-0.2	-0.3
Services	0.3	0.3	0.7	0.2	0.4	0.3	0.2	0.2
Addenda:
Core PCE ex-(food and energy)	0.1	0.2	0.5	0.3	0.3	0.3	0.1	0.2
Food	-0.1	0.0	0.5	0.1	0.0	-0.2	0.1	0.1
Energy goods and services	-1.9	-0.3	-1.4	2.3	1.2	1.2	-2.1	-2.1

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 last 4 months, the MOM inflation fell back to 0.0% in May 2024. In June 2024, it has marginally bounced back to 1.1%, showing some high frequency pressure on prices.
• MOM PCE inflation for goods bounced from -0.4% to -0.2% in June 2024; but stayed in the negative. The durable goods inflation bounced sharply from -0.8% to 0.0%, while non-durables inflation fell deeper from -0.2% to -0.3%.
• Services inflation MOM in June 2024 stayed static at 0.2% on an MOM basis, the same LEVEL AS IT WAS IN THE PREVIOUS MONTH.
• High frequency Core PCE inflation has inched up by 10 bps to 0.2% in June 2024 while the food inflation (MOM) is flat at 0.1%. After the sharp fall last month, even the MOM energy inflation stays static at -2.1% in June 2024.

More than the sober MOM inflation, the Fed will really take heart from the fact that PCE inflation has been in a range in calendar year 2024; and that in itself is good news!

DOES FED SHARE THE OPTIMISM OF CME FEDWATCH?

The CME Fedwatch has been increasingly getting optimistic about aggressive rate cuts by the Fed, but it remains to be seen if the Fed also shares that kind of enthusiasm. Here is a look at the CME Fedwatch probabilities after PCE inflation for June 2024 was announced.

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	4.7%	95.3%
Sep-24	Nil	Nil	Nil	Nil	Nil	Nil	0.4%	11.9%	87.7%	Nil
Nov-24	Nil	Nil	Nil	Nil	Nil	0.2%	7.8%	60.6%	31.4%	Nil
Dec-24	Nil	Nil	Nil	Nil	0.2%	7.4%	57.8%	32.9%	1.7%	Nil
Jan-25	Nil	Nil	Nil	0.2%	5.5%	44.2%	39.6%	10.1%	0.4%	Nil
Mar-25	Nil	Nil	0.1%	4.6%	37.8%	40.7%	14.8%	1.8%	Nil	Nil
Apr-25	Nil	0.1%	2.7%	24.0%	39.3%	25.5%	7.4%	0.9%	Nil	Nil
Jun-25	0.1%	1.9%	17.4%	34.5%	29.8%	13.1%	3.0%	0.3%	Nil	Nil
Jul-25	0.8%	8.4%	24.6%	32.6%	22.8%	8.8%	1.8%	0.2%	Nil	Nil
Sep-25	7.3%	20.9%	30.8%	25.1%	12.0%	3.4%	0.5%	Nil	Nil	Nil

Data source: CME Fedwatch

The Fed Futures market has been enthusiastic about rate cuts for quite some time now, and the latest GDP and PCE inflation data have made the first rate cut a fait accompli in September 2024. Here is what we read from the above data.

• The probability of the first rate cut happening in September 2024 is now 100%; although the chances of a rate cut on July 31, 2024 is only 4.7%.
• What about the situation at the end of 2024? By December 2024, there is a 98.3% probability of 2 rate cuts. There is a 65.4% probability of 3 rate cuts by December, and this could spike if Fed takes up the first rate cut in July itself as a pre-emptive measure.
• What about calendar 2025? By July 2025, there is a 98% probability that there would be 4 rate cuts in all, while there is a strong 96.1% probability of 5 rate cuts happening by September 2024.

A lot of these probabilities could change drastically based on when the Fed takes up the first rate cut. However, it does look like the CME Fedwatch has once again built in too much optimism. The Fed will, most likely, take up the first rate cut in September and give itself around 3 months to review the impact. The Fed has reiterated, time and again, that it does not want to be left holding the price stability problem once again. That only means that the Fed would prefer to err on the side of caution. Most likely, the Fed will not share the unbridled optimism of the CME Fedwatch.