"CPI data is music to the Fed's ears"
Inflation in the United States has shown signs of cooling, with the latest data indicating a potential shift in Federal Reserve policy.
The US Consumer Price Index (CPI) dipped by 0.1% in June, following a stagnant May. Core CPI, which excludes food and energy, increased by just 0.1% month-over-month, marking its smallest gain in nearly three years.
“The June CPI data is music to the Fed’s ears! Not just a slowing pace of inflation, but an actual month-over-month decline (aka deflation), at least in the overall CPI,” said First American chief economist Mark Fleming. “That hasn’t happened since May 2020 in the early days of the pandemic.”
The recent inflation figures have fueled traders’ optimism that the Federal Reserve might lower its key rate in September. Fed chair Jerome Powell, in comments to a congressional hearing, noted that the labor market also appears to be balancing after a robust start to the year.
Economists weigh in on CPI data
The only things holding back overall inflation at this point are higher-than-average inflation in services and shelter costs, according to Fleming.
“The shelter component of the CPI is particularly important because it is used in personal consumption expenditures, albeit with a lesser weight in the basket and is the Fed’s preferred measure of inflation,” he said.
“The index for shelter increased 5.1% year over year, a clear improvement over the 5.4% year-over-year growth in May, but still elevated. Shelter inflation is slow to respond to the current market changes in rent or owner’s equivalent rent, lagging current conditions by 12-to-18 months, but the most recent trend in market rents as a leading indicator of overall shelter inflation, is indicating further slowing in shelter CPI should be expected.”
Read more: US inflation cools for third straight month
Future Fed actions
Francis Généreux, principal economist at Desjardins, noted that “both May’s lack of growth and June’s slight pullback spell good news for US consumers, as well as for Federal Reserve officials,” he said.
“June’s numbers clearly show that the inflation is now trending in the right direction, while the opposite seemed true at the beginning of the year. Fears that inflation will heat up again are therefore gradually easing.”
Fleming and Généreux agree that the Fed will likely want more consistent data before making significant rate cuts.
“Knowing shelter inflation will continue to decline combined with the broader good inflation news has increased the likelihood of a September rate cut by the Fed and maybe another rate cut by the end of the year,” Fleming said. “Good news for homebuyers as that expectation alone is lowering mortgage rates now.”
“Does that mean that the battle has been won? Not yet. Fed authorities will probably want to see more results like those we’re seeing today,” Généreux said, adding that Desjardins still calls for two rate cuts in 2024, probably close to the end of the year.
“It’s also important to remember that our hopes have been dashed before—several times over the last few years—and inflation has temporarily cooled in previous summers, even when the data coming out of the US has been seasonally adjusted. So we’ll need to remain cautious,” Généreux said.
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