This week, the middle of 2024, some goods news on U.S. inflation was released, which may allow the Fed to lower its key interest rate at least once this year. The U.S. Consumer Price Index (CPI) was actually flat in May (although still up 3.3% from a year ago). Keeping May inflation in check were two volatile components – energy prices (down 2%) and food prices (just a 0.1% increase).
Just as notable, the Producer Price Index (PPI), a measure of prices producers receive for goods and services in the open market, was also down 0.2% in May versus expectations for a 0.1% rise. Excluding food and energy, the PPI was flat in May.
Given this latest inflation data, futures markets are now pricing in a 73% chance the Fed will cut interest rates at its September 18 meeting—a substantial jump from the 50% probability earlier this week.
There is some concern that the Fed will not act in September regardless, in an effort to avoid the perception of bias given the upcoming U.S. Presidential election. However, if the positive inflation data of May continue through August, the Fed may have enough confidence for a rate cut. And that could be good news for the markets unless the economy also shows significant signs of weakening.
Retailers Starting to Lower Prices
As we have pointed out in the past, U.S. monetary policy works with a significant lag with each interest rate increase affecting the economy somewhere in the range of 16 months later. This means the three final rate increases (which brought the Fed funds rate above 5%) have yet to play out in the economy. And we are starting to see stable or falling prices.
On the goods front, major retailers including Target, Amazon and Walgreens are starting to cut prices, having perhaps raised them too far post-pandemic, causing consumers to pare back on purchases or switch to lower priced alternatives. Retailers and other businesses’ recent drive to reduce prices may be a trend showing up in the data and could continue to drive inflation lower.
Inflation in “core services,” which includes rents, tends to be stickier but we are starting to see some cracks there too.
Fed Remains Vigilant
Since July of last year, inflation has generally been declining yet the Fed has kept rates the same. This has had a tightening effect since the real rate of interest (the nominal rate minus inflation) rises when inflation drops. The Fed has maintained this stance despite U.S. unemployment hitting 4% two quarters ahead of the Fed’s year-end 2024 projection, and disinflationary signs within the Core CPI (minus food and energy prices).
In its statement this week, the Fed indicated that inflation remains an ongoing concern (its target for inflation is 2%), and it is therefore maintaining a somewhat “hawkish” stance. The Fed expects to cut interest rates just once in 2024, given that they increased their expectation for their favored gauge of inflation – the Personal Consumption Expenditures (CPE) Price Index – to 2.8% (from their previous forecast of 2.6%) and they expect U.S. unemployment to remain at 4%. It will be interesting to see how the markets react with more time to digest the data and the Fed statement.
Per usual, we will be keeping a close eye on inflation and economic data as the summer progresses. Of particular interest is the U.S. employment rate and jobs data. Unemployment is a lagging indicator, but once it starts rising as it has this year from 3.7% to 4%, it tends to continue rising and gain momentum.
================================================================
Closer Look at May Inflation Gauges
Source: Consumer Price Index News Release – 2024 M05 Results (bls.gov)
The Consumer Price Index (CPI) did not change in May from April and is up 3.3% year-over-year. The Core CPI (minus food and energy) rose just 0.16%, which was the weakest print since August 2021; in the past 12 months, Core CPI is up 3.4% surprising markets to the downside.
CORE GOODS
Core Commodities. Remained essentially flat in May (-0.04%).
Vehicles: New vehicle prices fell 0.5%, the fifth consecutive month of declines. Used car and truck prices fell dramatically from last year at a 9.3% pace – a key driver of the weaker May CPI data.
Apparel: Decreased by 0.3%, the first drop in three months.
CORE SERVICES
Core services CPI rose by only 0.2% mostly due to rents which, by the Fed’s calculations, are still increasing. When you exclude rents, Core Services CPI (otherwise known as the “supercore”) actually dropped 0.04% in May, the weakest reading dating back to September 2021. Key details include:
Shelter/Rents: Shelter and rents once again exerted pressure on CPI up 0.4% MoM (or 5.3% YoY) but likely have more room to fall, given the Fed’s clunky calculation tends to lag behind actual market indicators such as Zillow’s Observed Rent Index.
Motor Vehicle Insurance Prices: Over the past several months, auto insurance premiums have been skyrocketing likely due to the significant rise in auto prices during the pandemic causing insurers to recalibrate premiums. Fortunately, in May, they dropped marginally (0.12%). Any continued deceleration would be a positive for relieving recent inflationary pressures.
Airfares: Airfares dropped 3.6% in May.
