US CPI report gives the Fed the green light to start cutting interest rates

Today’s CPI report from the US painted a picture of widespread disinflation across the US economy. An interest rate cut is coming soon, and we maintain our position that a first cut will be delivered in September.

The CPI report for June showed annual headline inflation slowing by 0.3% to 3.0%, while the annual monthly rate actually declined from 0.0% to -0.1%. The core annual rate slowed by 0.1% to 3.3% and the monthly core rate by a similar amount to register growth of just 0.1%. It is a set of numbers that should go a long way to confirming for the FOMC that CPI is on a definitive path back to target.

But aside from the headline numbers, equally pleasing for the Fed will be their make-up, which shows pricing pressures in all sectors of the US economy are now cooling. Primary rents rose by just 0.26%, and owners’ equivalent rents (OER) by 0.27%, the smallest monthly increases both series have posted since April 2021. We have alluded previously to the fact that private sector measures of rents, such as the Zillow index, have been pointing to slowing rents for some time now, and finally this is now appearing in the official data. It is also worth noting that the impact of the decision to increase the weight in the OER calculation of single-family detached homes, which had boosted the OER number, have now fully played out, suggesting the number will be softer going forward.

Elsewhere, prices of core-services ex rents were unchanged for the second month in a row, although the reported 5.0% drop in airline fares will have played a significant role here (perhaps crucially, this will be absent from the all-important Personal Consumption Expenditure (PCE) figure to be published later this month, which uses airfares derived from the PPI data to calculate its measure of inflation, a figure which can diverge from the equivalent CPI number). Meanwhile, core goods prices fell by 0.1%, with a 1.5% drop in used car prices and 0.2% fall in new vehicle prices playing a key role here. But even stripping out the auto sector leaves core goods prices rising by just 0.1%, a rate of growth that will be of no concern to the Fed and which paints a picture of a flat underlying trend.

Overall, today's report provide the Fed with the green light needed to begin cutting interest rates. And looking ahead, the economic landscape suggests that pricing pressures should continue to ease over H2, with the key drivers of the post-pandemic surge in inflation having either mean-reverted or in the process of doing so. Retail margins are under increasing pressure as consumers cut back spending in the face of lower income growth; the labour market is continuing to soften, pulling down wages growth in the process; supply-chains have now largely returned to their pre-pandemic state; and global food and energy prices remain benign.

However, the CPI figures are not the full story, and it is how they will play out in the forthcoming PCE report that will matter most to the Fed. The CPI numbers are used to calculate two-thirds of the PCE’s components; the remaining one-third are derived from the PPI numbers, which are released tomorrow. Typically the PPI numbers are more volatile than are the CPI figures. However, a PPI report tomorrow in line with expectations should leave monthly core PCE below 0.20%, a comfortable rate of growth for the Fed and which in itself presents no barrier to loosening monetary policy.

All in all, therefore, our base case scenario of a first cut being delivered in September remains in place, with further cuts expected before end-2024.