Stronger US PPI numbers still allow the Fed to cut interest rates in September

The stronger than expected headline reading for today’s US PPI numbers at first glance looks worrying, pointing to the need for the Fed to delay cutting interest rates until much later in the year. But a read-down into the report’s details shows inflationary pressures to be more benign than the headlines suggest, leaving a September rate cut still firmly on the table.

Headline monthly PPI for June rose by 0.2%, slightly above the consensus expectation of a 0.1% reading. Net revisions were also made to the May figure of 0.2%, leaving it flat on the month at 0.0%. But the more worrying feature was a core monthly print of 0.4%, with May's core number also revised upwards by 0.3%. At face value, a core reading of 0.4% appears incompatible with a decision to lower interest rates and would suggest a cut appearing as soon as September is now off the table. However, the details of the report suggest differently.

Much of today's increase is attributable to a 1.9% jump in wholesale and retail margins, represented in the data as ‘trade services’. These are essentially the pricing increases shop keepers and retail outlets generally add onto the prices of the items they sell in order to cover costs such as their own time, their energy and rental costs etc. It was the huge increase in margins post-covid that was one of the key drivers of the subsequent surge in inflation, as retailers were able to raise prices in the face of the unleashing of the pent-up demand built up during pandemic lockdowns. But our argument is that not too much weight should be placed on this increase. The series is volatile and subject to revisions, while the slowdown being seen in consumer spending will naturally see margins retreat as retailers are forced to cut prices and offer discounts to generate sales. Removing trade services from the PPI calculation leaves the core PPI ex-trade services figure unchanged on the month at 0.0%, and pointing to a much more benign inflationary picture than the headline numbers suggest. Core goods prices were also unchanged.

What all this means is that, taking into account the above and reading it alongside yesterday’s CPI numbers, the monthly core PCE deflator number for June to be published on 26 July - the Fed's preferred measure of inflation - is on course to print below 0.2%, which if delivered should ensure the quarter-on-quarter annualized core PCE growth rate for Q2 will fall from the 3.7% reading seen in Q1 to sub-3%. It is hard to predict precisely what the number will be, in no small part because of the seasonal adjustment factors applied to it. But nonetheless, a reduction approaching 1% will provide further evidence that pricing pressures in the US are definitively moving lower and should present no barrier to the FOMC cutting interest rates at its September meeting.