US inflation falls, as Fed minutes says “Enough”

  • 04 Jun 2024
  • Read 6 mins read

An action packed day for US data flows

It was an action-packed day for US data flows. On the one hand, the US inflation came in sharply lower at 5.0% in March 2023 compared to 6.0% in February 2023. This has been one of the sharpest falls in inflation in the last one year. Now, the US consumer inflation is a full 410 basis points below the peak levels recorded in June 2022. On the other hand, the US Fed minutes (published 21 days after the March Fed meeting) clearly used the R-word, hinting that the banking crisis could well plunge the US economy into recession by the end of the year. Now, the CME Fedwatch is estimating that the rate cuts by the Fed may happen as early as this year itself to prevent a full-fledged recession. We have to wait and watch.

 

A sharp fall in US consumer inflation in march

US consumer inflation fell by 100 bps from 6.0% to 5.0%. This was driven lower by food inflation and a sharp fall in energy inflation into negative territory. However, the core inflation (excluding food and energy) was actually up by 10 bps over February. 

Inflation Basket CategoryMar 2023 (YOY)Feb 2023 (YOY)Inflation Basket CategoryMar 2023 (YOY)Feb 2023 (YOY)
Food Inflation8.50%9.50%Core Inflation5.60%5.50%
Food at home8.40%10.20%Commodities less food and energy1.50%1.00%
  • Cereals and bakery products
13.60%14.60%
  • Apparel
3.30%3.30%
  • Meats, poultry, fish, and eggs
4.30%6.80%
  • New vehicles
6.10%5.80%
  • Dairy and related products
10.70%12.30%
  • Used cars and trucks
-11.20%-13.60%
  • Fruits and vegetables
2.50%5.30%
  • Medical care commodities
3.60%3.20%
  • Non-alcoholic beverages
11.30%12.30%
  • Alcoholic beverages
4.50%4.90%
  • Other food at home
11.10%12.40%
  • Tobacco and smoking products
6.90%6.70%
Food away from home8.80%8.40%Services less energy services7.10%7.30%
  • Full service meals and snacks
8.00%8.00%Shelter8.20%8.10%
  • Limited service meals 
7.90%7.20%
  • Rent of primary residence
8.80%8.80%
Energy Inflation-6.40%5.20%
  • Owners’ equivalent rent
8.00%8.00%
Energy commodities-17.00%-1.40%Medical Care Services1.00%2.10%
  • Fuel oil
-14.20%9.20%
  • Physician Services
0.50%1.20%
  • Gasoline (all types)
-17.40%-2.00%
  • Hospital Services
2.70%3.60%
Energy services9.20%13.30%Transport Services13.90%14.60%
  • Electricity
10.20%12.90%
  • Motor vehicle Maintenance
13.30%12.50%
  • Natural gas (piped)
5.50%14.30%
  • Motor vehicle insurance
115.00%14.50%
Headline Consumer Inflation5.00%6.00%
  • Airline Fare
17.70%26.50%

Data Source: US Bureau of Labour Statistics

The US economy appears to be a classic case of rate hikes doing the job. Between March 2022 and March 2023, the Fed has raised rates by 475 basis points. During this period, the US consumer inflation has fallen by 410 bps from 9.1% to 5.0%. In short, the rate hikes in the US have been instrumental in bringing down inflation. Between June 2022 and March 2023, the US consumer inflation has fallen in each of the months.

What do we infer from the above table? The fall in inflation in the US in March 2023 has been triggered by lower food inflation and a sharp fall in energy inflation into negative territory. This has more than offset the marginal increase in core inflation. Even in the core inflation basket, the pressure has come from the core sector commodities and not from the core sector services. The negative inflation in energy is largely due to the inflated base effect. Food inflation has been lower across most of the core products.

What do the Fed minutes tell us?

There are two ways to look at the Fed minutes. One is what the Fed says and the other is how the markets interpret what the Fed says. The latter is captured by the CME Fedwatch, which essentially captures the future probability of rate trajectory. Check the table below.

Fed Meet325-350350-375375-400400-425425-450450-475475-500500-525525-550
May-23NilNilNilNilNilNil31.2%68.8%Nil
Jun-23NilNilNilNilNilNil29.1%63.4%7.4%
Jul-23NilNilNilNilNil16.3%48.13%32.2%3.3%
Sep-23NilNilNilNil12.0%39.6%36.3%11.2%0.9%
Nov-23NilNilNil7.5%29.2%37.5%20.7%4.8%0.4%
Dec-23NilNil6.1%25.1%35.9%23.8%7.8%1.2%0.1%
Jan-24Nil4.8%21.2%33.7%26.3%11.1%2.5%0.3%Nil
Mar-244.3%19.6%32.5%27.1%12.6%3.4%0.5%NilNil

Data source: CME Fedwatch

If you find these numbers to be mumbo jumbo, here is the quick summary that really matters.

  • The market is shifting to the left; which means it is expecting the rates to be lower much sooner. In fact, the markets are indicating that the Fed is very close to the top, if not already at the top. The worst-case scenario is just 25 bps higher rates from here. 
     
  • Terminal levels for the Fed interest rate now look to be around 5.25% to 5.50% at the most. The CME Fedwatch is also pegging the possibility that rates may move lower from the end of 2023 itself, instead of waiting till 2024.

So, we have a situation where US rates may be close to topping out and inflation is falling. How to read this combination of data?

How to read US Inflation and US Fed minutes?

The Fed minutes have used the Recession word in minutes, which could be an outcome of the banking crisis in the US. That is not great news. A slowdown in the US could have larger repercussions, especially for countries like India in terms of tech spending and export demand. The US may finally be facing the dual push from falling inflation and growing recession risks. That means US rates could top out sooner, although inflation is still some way from the 2% target. It promises to be an interesting story!