CPI Review: Positive Surprise Unlikely to Shift Fed Policy

Summary

• Core MoM CPI was above market expectations while the rest of the release was in line.
• OER and supercore services inflation accelerated from July while goods prices continued falling.
• Yesterday’s print is unlikely to shift the Federal Reserve (Fed’s) focus on employment rather than on inflation risks.

Market Implications

• I expect the Fed to cut 25bp next week and 75bp for the whole of 2024, in line with market expectations this month, but lower than market expectations of about four cuts for 2024.

Upside Surprise

August MoM core CPI at 28bp was above expectations of 0.2%. The rest of the release was in line (Table 1).

The key change relative to July was an acceleration in OER and supercore services inflation (Table 2).

Core Goods Deflation Continued

Excluding used cars, core goods inflation remained negative (Table 3, Chart 2). Used car prices fell further.

Housing Inflation Accelerated

August’s owners’ equivalent rent (OER) accelerated to 50bp MoM up from 36bp in July and 28bp in June (Chart 2).

In my review of the June CPI, I warned the dip in OER inflation might not last due to a structural housing shortage in the US. Two months later it looks like June was an outlier.  Market rent indices (that aggregate rents paid by tenants moving to new units) are not slowing (Chart 3).

Supercore Inflation Turns Up for the Second Month

Supercore inflation was 33bp, up from 21bp in July (Chart 4). The negative prints in May and June now look like outliers.

Transport services and lodging away inflation accelerated while recreation and other personal services inflation slowed.

Since the pandemic, transportation has increased noticeably faster than other supercore services, mainly on the back of fast car insurance inflation (Chart 5). Car insurance prices have continued rising even though the cost of new and used cars, parts and repair services is stabilizing (Chart 6). This could suggest competition issues in car insurance and risk of sustained medium-term car insurance inflation.

Disinflation Trend Continued

Despite yesterday’s core surprise, on a 6m SAAR basis, measures of inflation trends such as core, median price, trimmed mean or sticky inflation continued slowing (Chart 7).

Market Consequences

Following yesterday’s release, markets priced out the risk of a 50bp cut at next week’s FOMC and lowered their estimate of 2024 easing to four and a quarter cuts from four and a half cuts.

The Fed tends not to react to single data points. Also, all August CPI acceleration was with services rather than goods and the Fed expects services disinflation to be slower than goods.

At Jackson Hole, Fed Chair Jerome Powell made clear the Fed is now more focused on employment than on inflation risks. The latest CPI print is unlikely to have changed this assessment.

Yesterday’s CPI supports Waller’s call for policy nimbleness. I still expect a 25bp cut next week and three cuts this year.

(The commentary contained in the above article does not constitute an offer or a solicitation, or a recommendation to implement or liquidate an investment or to carry out any other transaction. It should not be used as a basis for any investment decision or other decision. Any investment decision should be based on appropriate professional advice specific to your needs.)