US July inflation at 2.9%; lowest level since March 2021

16 Aug 2024 , 09:30 AM

US FED HAS ONE MORE REASON TO CUT RATES

In the last few weeks, the big story in the global markets has been all about the likely slowdown in the US economy. It all began with the labour data which showed a sharp spike in the jobless filings in July 2024. Also, the rate of unemployment spiked to 4.3% from 4.1% in the previous month. However, the secular trend is more worrying. The rate of unemployment has gone up from under 3.5% last year to 4.3% in July 2024. This is exactly what the Fed was looking for since very low unemployment levels and high wages are not compatible with low inflation. That should get addressed, more so since the consumption spending is also going down. However, that has created another concern. For over 2 years, the US economy surprised the market by avoiding a hard landing despite overtly hawkish stance of the Fed. Now that appears to be unravelling, but these are early days still.

US yoy inflation for July 2024 came in 10 bps lower at 2.9%. In fact, even as core inflation is down 10 bps, most of the pressure on the headline inflation has come from the index for shelter which has accounted for nearly 90% of the monthly increase. What is more interesting is that the 2.9% yoy inflation in July 2024 is the lowest inflation figure seen in the last 40 months and such low levels of inflation were last ween in March 2021. Even the core inflation is at a 3-year low, but more importantly, the pressure from the energy basket appears to have abated. Food inflation remained static at 2.2%. What does this mean ahead of the next Fed statement in mid-September. The US Fed will have additional data points like the September CPI inflation, August PCE inflation and the outcome of the Jackson Hole symposium to be held in the US between August 22 and August 24, 2024. All these will jointly provide the data bank for the Fed to decide on rate cuts in September.

LOWER JUL-24 HEADLINE INFLATION TRIGGERED BY CORE BASKET

In the last few months, the energy inflation had been the swing factor while core inflation was trending lower and food inflation was relatively stable. For July, while the food inflation is flat at 2.2%, it is the core inflation is down 10 bps at 3.2%. The energy inflation is marginally up by 10 bps at 1.1%, but the pressure of the last few weeks is gone. The global crude oil prices have also tapered after the fears of economic slowdown in the US and China raised the spectre of weak demand for oil. The big question that the Fed will debate is whether this can be construed as a conclusive move towards the 2% mark. Remember, the CPI inflation in the US is still 90 bps away from the 2% target, although the PCE inflation (the FOMC benchmark) is much closer to the 2% mark. The table below captures the monthly data on the inflation break-up for July 2024 versus June 2024.

Inflation Basket Category	Jul 2024 (YOY)	Jun 2024 (YOY)	Inflation Basket Category	Jul 2024 (YOY)	Jun 2024 (YOY)
Food Inflation	2.20%	2.20%	Core Inflation	3.20%	3.30%
Food at home	1.10%	1.10%	Commodities less food and energy	-1.90%	-1.80%
·          Cereals and bakery products	0.00%	0.50%	·          Apparel	0.20%	0.80%
·          Meats, poultry, fish, and eggs	3.00%	2.60%	·          New vehicles	-1.00%	-0.90%
·          Dairy and related products	-0.20%	-0.10%	·          Used cars and trucks	-10.90%	-10.10%
·          Fruits and vegetables	-0.20%	-0.50%	·          Medical care commodities	2.80%	3.10%
·          Non-alcoholic beverages	1.90%	1.50%	·          Alcoholic beverages	1.90%	1.80%
·          Other food at home	0.90%	1.60%	·          Tobacco and smoking products	7.90%	8.20%
Food away from home	4.10%	4.10%	Services less energy services	4.90%	5.10%
·          Full service meals and snacks	3.80%	3.90%	Shelter	5.10%	5.20%
·          Limited service meals	4.30%	4.30%	·          Rent of primary residence	5.10%	5.10%
Energy Inflation	1.10%	1.00%	·          Owners’ equivalent rent	5.30%	5.40%
Energy commodities	-2.00%	-2.20%	Medical Care Services	3.30%	3.30%
·          Fuel oil	-0.30%	0.80%	·          Physician Services	0.70%	0.80%
·          Gasoline (all types)	-2.20%	-2.50%	·          Hospital Services	6.10%	6.90%
Energy services	4.20%	4.30%	Transport Services	8.80%	9.40%
·          Electricity	4.90%	4.40%	·          Motor vehicle Maintenance	4.60%	6.00%
·          Natural gas (piped)	1.50%	3.70%	·          Motor vehicle insurance	18.60%	19.50%
Headline Consumer Inflation	2.90%	3.00%	·          Airline Fare	-2.80%	-5.10%

Data Source: US Bureau of Labour Statistics

One point to note is that the US Federal Reserve still relies more on PCE inflation for rate decisions; than on CPI inflation. The reasons are fairly straightforward. PCE inflation is based on personal consumption expenditure and factors in consumption and price trends. However, CPI inflation acts as the lead indicator for PCE inflation and also sets the basis for PCE inflation; so, this figure still matters from a policy perspective. The general practice is that CPI inflation is announced in the US before the middle of the month while the PCE inflation is announced towards the end of the month, incorporating more data points.

• Let us start with food inflation. Between June 2024 and July 2024, food inflation was flat at 2.2%. The upward thrust to inflation came from high protein products like meat, poultry, fish, and eggs; as well as vegetables, fruits, and non-alcoholic beverages. On the other hand, the down ward pressure on prices came from prices of cereals, bakery products and food at home.
• Energy inflation was up by 10 bps in July 2024 to 1.1%. Electricity and gasoline saw higher prices in the month of July 2024 as compared to June. However, in the energy basket, natural gas saw a 220 bps fall in July compared to June 2024 at 1.5%.
• Finally, let us turn to the core inflation, which was again lower by 100 bps at 3.2% in July 2024. The upward pressure came from airline fares and alcoholic beverages. On the other hand, there were also items that exerted downward pressure on the core inflation. These included apparel, used cars, tobacco products, hospital services, motor vehicles maintenance and motor vehicles insurance.

While the headline CPI inflation still remains 90 bps above the 2% inflation target, what is gratifying is that energy inflation has sobered substantially, and core sector continues to support lower consumer inflation.

JULY 2024 MOM INFLATION BACK IN POSITIVE ZONE

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)
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%
Jun 2024	0.2%	(2.0%)	0.1%	(0.1%)
Jul 2024	0.2%	0.0%	0.2%	0.2%

Data Source: US BLS (negative figures in brackets)

The headline MOM inflation turned around from negative to positive in July, but there was contrasting action in the components. On an MOM basis, food inflation was flat and core inflation was up. However, MOM fuel inflation bounced from negative to neutral, and that led the headline MOM inflation to bounce from negative to positive zone. Here is what we read from the break-up of the MOM US consumer inflation for July 2024.

1. MOM food inflation in July 2024 was flat at 0.2%. Out of the 6 store food categories; 3 saw an increase in inflation and 3 saw fall in inflation. The higher inflation came from meat, poultry, fish eggs; fruits & vegetables, and non-alcoholic beverages in July 2024. The downward thrust to food inflation MOM came from food at home, cereals & bakery products, and dairy related products in July 2024.
2. The MOM Energy inflation bounced from -2.0% in June 2024 to a neutral 0.0% in July 2024. The gasoline index was unchanged on a MOM basis. Among others, electricity index and the fuel oil index increased in July 2024 while natural gas was down.
3. The MOM Core inflation growth was 0.2% in July 2024 as compared to 0.1% in June 2024. The upward pressure comes largely from shelter, rentals, owners’ equivalent rent, and lodging away from home. On the downside, the medical care index, hospital services index and the index of physician services were lower in July as compared to June 2024.

Overall, the high frequency MOM inflation saw a sharp bounce in July 2024 as it turned around from negative to positive. Clearly short term price pressures are not going away in a hurry, and that is something the Fed would be worried about.

CME FEDWATCH MORE OPTIMISTIC ABOUT RAPID RATE CUTS

Let us first look at the CME Fedwatch prior to the latest CPI inflation data. This factors in the data on PCE inflation, the US Fed policy statement, and the concerns over a US slowdown. Even prior to the CPI inflation data, the CME Fedwatch was very positive about 2 to 3 rate cuts in 2024 and another 4-5 rate cuts in 2025. Here is how the CME Fedwatch looked like before the CPI inflation data was announced.

Fed Meet	275-300	300-325	325-350	350-375	375-400	400-425	425-450	450-475	475-500	500-525
Sep-24	Nil	Nil	Nil	Nil	Nil	Nil	Nil	Nil	48.5%	51.5%
Nov-24	Nil	Nil	Nil	Nil	Nil	Nil	13.5%	49.3%	37.1%	Nil
Dec-24	Nil	Nil	Nil	Nil	3.9%	23.8%	45.8%	26.5%	Nil	Nil
Jan-25	Nil	Nil	Nil	3.8%	23.3%	45.3%	27.0%	0.7%	Nil	Nil
Mar-25	Nil	Nil	3.5%	22.1%	43.9%	28.1%	2.3%	Nil	Nil	Nil
Apr-25	Nil	2.3%	15.4%	36.1%	33.8%	11.6%	0.9%	Nil	Nil	Nil
Jun-25	1.4%	10.6%	28.6%	34.6%	19.7%	4.8%	0.3%	Nil	Nil	Nil
Jul-25	5.6%	17.5%	30.9%	28.9%	13.9%	3.0%	0.2%	Nil	Nil	Nil
Sep-25	14.5%	24.4%	29.8%	21.2%	8.3%	1.6%	0.1%	Nil	Nil	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 50-75 bps rate cut by the end of 2024 with another 100-125 bps happening by the second half of 2025. Here is how the CME Fedwatch changed after the announcement of the US consumer inflation on August 14, 2024.

Fed Meet	250-275	275-300	300-325	325-350	350-375	375-400	400-425	425-450	450-475	475-500	500-525
Sep-24	Nil	Nil	Nil	Nil	Nil	Nil	Nil	Nil	Nil	43.5%	56.5%
Nov-24	Nil	Nil	Nil	Nil	Nil	Nil	Nil	16.5%	48.4%	35.0%	Nil
Dec-24	Nil	Nil	Nil	Nil	Nil	6.5%	29.1%	43.1%	21.2%	Nil	Nil
Jan-25	Nil	Nil	Nil	0.6%	8.5%%	30.3%	41.3%	19.4%	Nil	Nil	Nil
Mar-25	Nil	0.1%	1.4%	10.6%	31.4%	39.1%	17.5%	Nil	Nil	Nil	Nil
Apr-25	Nil	0.8%	6.8%	22.9%	35.9%	26.3%	7.2%	Nil	Nil	Nil	Nil
Jun-25	0.6%	5.5%%	19.4%	33.1%	28.4%	11.4%	1.6%	Nil	Nil	Nil	Nil
Jul-25	3.2%	11.9%	25.7%	30.9%	20.6%	6.9%	0.8%	Nil	Nil	Nil	Nil
Sep-25	10.9%	20.8%	29.0%	24.3%	11.8%	3.0%	0.3%	Nil	Nil	Nil	Nil

Data source: CME Fedwatch

There is one clear trend emerging in the CME Fedwatch post the consumer inflation in the US tapering to 2.9% for July 2024. The CME Fedwatch has become a lot more dovish. Here we look at some of the key milestone periods over the next 14 months.

• Let us first focus on the September 2024 Fed meeting, which is where most of the debate is currently centred. According to the CME Fedwatch post the inflation data, there is a 100% probability of a 25 bps rate cut and a 43.5% probability of 50 bps rate cuts in September. However, by the November meet, this probability of 50 bps rate has gone up to 100%.
• Let us turn to the last month of December 2024. There is a 100% probability of 75 bps rate cut by December and a probability of 79% for 100 bps of rate cuts. This is a lot more aggressive than what the Fed has hinted, and it also looks a lot more optimistic.
• By the April 2024 milestone, there is a 93% probability of 150 bps of rate cuts and 67% probability of 175 bps of rate cuts. If you look at the last milestone of September 2024, the expectations are only slightly more aggressive. That means; the CME Fedwatch expects most of the Fed rate action to be front-ended. That looks unlikely; at least if you go by the recent speech delivered by Fed governor Michelle Bowman.

The quick takeaway is that the probability of rate cuts and the intensity of rate cuts have gone up sharply after the 10 bps fall in the US consumer inflation in July 2024. However, the kind of dovishness pencilled by the CME Fedwatch will need either a major supporting factor like sharp fall in inflation, or a major disruption like a sharp fall in GDP growth. In the absence of one of these extreme situations, so much of aggression may be misplaced.

ARE THE MARKETS JUSTIFIED IN EXPECTING 3-4 RATE CUTS IN 2024?

The CME Fedwatch is probably indulging in a bit of wishful thinking. That is like using your analytical powers to justify what you wish were true. Based on the tone of the Fed governors, it looks very unlikely that they would risk such outright dovishness at a time when the actual inflation is still about 90 bps from the 2% target. The markets may be reading too much into a single month data on unemployment. The markets are pencilling in up to 8 rate cuts by September 2025. The CME Fedwatch may believe that is the need of the hour, but that is not the way the US Federal Reserve works.