The market has spoken, and it says the Federal Reserve will not be raising rates tomorrow.
After May’s inflation print turned out to be slightly lighter than forecasts, Fed funds futures are priced in to make it almost certain that the US central bank will keep rates steady in its 5-5.25 per cent range.
(For details: The CME’s FedWatch shows futures market pricing of a 94 percent probability of US rates dropping this week, compared to 79 percent for yesterday.)
But how much inflation eased, exactly? While lower energy costs and a slowdown in food inflation dragged down the broader inflation data, inflation in shelter and used cars remained strong. So it was a bit of a mixed bag, which helps explain why a rally in Treasuries was set off by the afternoon CPI report.
One thing that the CPI (and market reaction) shows is that it’s unhelpful to look at the broad headline numbers without digging into the underlying drivers. So let’s take a look at some of the different areas with the help of this chart from Wells Fargo:
1) Rent. US rent inflation eased slightly, with May shelter costs up 0.5-percent from the previous month (compared to a 0.6-percent increase in rents in April, and 0.5 for owner-equivalent rents). That’s in line with a prediction from economists at Goldman Sachs earlier this week.
Hotels, for their part, saw a significant jump in prices, with home stays rising 1.8 percent for the month on a seasonally adjusted basis and 2.6 percent non-adjusted.
Overall, shelter inflation was the largest contributor to the increase in CPI for the month.
2) Used Cars. Inflation in old cars and trucks has not come down Absolutely on a seasonally adjusted basis. Prices rose 4.4 percent in May alone, in line with April’s jump of 4.4 percent. Used cars and trucks were the second largest contributor to the month’s inflation; The recent drop in used car wholesale prices hasn’t even begun to be reflected for buyers.
Car insurance didn’t help either! It was up a seasonally adjusted 2 per cent for the month and 17 per cent during the year ended May.
3) Food. The price of groceries rose in May after a few months of decline, but only increased by about 0.1 percent.
Egg prices fell by 13 per cent (!) for the month as supply pressure eased earlier this year.
Oh, and pork costs were down 0.8 percent from the previous month. Looks like the “summer of pork” is really on.
The mixed data “is likely to help confirm pre-release bias in the outlook among investors,” says Jefferies economist Thomas Simons:
The soft landing/”spotless deflation” camp could point to the headline slowdown, the decline in core services, and the fact that the headline would have been flat if it weren’t for used cars as a sign that the Fed is getting what it wants. is what it wants without having to engineer a major slowdown in development. However, the hard landing camp could point to a decline in energy prices that will not be repeated, and continued pressure in both shelter and core service prices can be expected as reasons to believe in consumer discretionary spending. I will retreat. We are already heading towards a recession.
We’ve been in the hard landing camp for a while now, and we have no reason to change based on this data. It also changes nothing for the Fed, as they are likely to hold off at tomorrow’s meeting, and are unlikely to be forced to extend this cycle again.
But really, not much has changed, says Michael Ferroli of JP Morgan:
Today’s data could turn out to be a hopeful note, especially if you consider that industry data on fares and supplier distribution indices suggest a softening of fares and freight prices. However, the same argument could have been made a few months ago, and so far, it’s hard to see much improvement. We expect May core PCE to rise 0.35%, or 4.7% on a year-ago basis, which would remain unchanged from April.
“Directional progress should not be confused with mission completion,” say Wells Fargo’s Sarah House and Michael Pugliese.
We expect a more noticeable drop in core prices in the coming months. Shelter inflation appears to have peaked and should slow in the second half of the year. The recent surge in used auto prices is not sustainable, and we believe the category should begin a downward trend soon. Barring used autos, there have been signs of moderation in core articles inflation amid normalization of supply chains and moderation in demand.
[ . . . ] If, as we expect, core CPI is still rising at a 3.0%-3.5% annualized rate in the fourth quarter of this year, it should prevent the FOMC from cutting rates until 2024. In the near future, today’s data should be locked. June FOMC meeting pause, ie no rate hike. However, we expect Chair Powell’s press conference and latest summary of economic projections to indicate that another rate hike is still in the cards.
Source: www.ft.com
