Inflation and the Fed – Part III — Evening Brief – 07.12.24
Today’s producer price index for June was anticipated to provide the markets with an additional indication of the ongoing disinflationary trend, following the release of the consumer price index on Thursday, which was lower than expected. Nevertheless, the print indicated that the trend may not be as smooth as anticipated.
Following May’s month-over-month deflationary sign, primarily due to a drop in energy costs, June was predicted to show a modest 0.1% increase. On cue, headline PPI printed a bit hotter-than-expected at +0.2% month-over-month, while May was revised higher, sending the year-over-year rate up to 2.6%, above the projected 2.3% and the highest reading since March 2023.
Core PPI also printed on the hotter side, rising 0.4% in June and above expectations for a 0.2% gain, pushing the year-over-year rate up by 3.0%, which is also the hottest since March 2023.
The increase in PPI was driven by a comeback in service costs, as energy remains deflationary for now. The June rise in the final demand index can be attributed to a 0.6% increase in final demand service prices. In contrast, the index for final demand items fell 0.5%. However, the issue is that the pipeline for PPI (intermediate demand) is increasing.
While the PPI data was not what the doves ordered, it did little to change probabilities around an interest rate cut by the FOMC in September. Post data, the markets were pricing in 94% odds of a quarter-point rate cut at the September meeting, compared with 87% after the CPI release, and 92% odds of at least 50 basis points in cuts by the end of 2024 compared with 85% after the CPI data. Odds of three quarter-point rate cuts this year have climbed to 49% from 29% a week ago compared with 39% from 27.5%, respectively following the CPI print.
With inflation slowly returning to the Fed’s 2% objective, Nomura economist Aichi Amemiya and colleagues wrote on Thursday that “the pace of easing should remain limited to one 25bp cut per quarter as long as labor data remain resilient.”
This suggests that the Fed will lower its benchmark interest rate by a quarter point in September and again in December. However, given the deteriorating labor-market trajectory, investors expect a third rate cut this year.