This Week's State Of The Economy - What Is Ahead? - 14 June 2024

By: Taro Chellaram /Wells Fargo Economics & Financial Report/Jun 20, 2024

This Week's State Of The Economy - What Is Ahead? - 14 June 2024

Inflation Cools as Summer Begins

A bevy of soft inflation data for May fueled optimism that the Federal Reserve will begin cutting rates at the September FOMC meeting. On Wednesday, the May CPI data showed that consumer prices were unchanged in the month, the first flat reading for the CPI since July 2022. Falling energy prices and a very modest increase in food prices helped to keep headline CPI in check. Excluding food and energy, core CPI increased by a "low" 0.2% (0.16% before rounding), the smallest monthly increase since August 2021 (chart). Sticky services inflation finally showed signs of easing, registering 0.2% amid price declines for airfares (-3.6%), motor vehicle insurance (-0.1%) and lodging away from home (-0.1%). Goods prices were flat over the month as higher prices for prescription drugs, used autos, motor vehicle parts & equipment and tobacco products offset price declines for new vehicles, apparel and communication commodities.

This week's data signal that progress continues on the inflation front, even if that progress has been frustratingly gradual and bumpy at times. Consumer prices have increased 3.3% over the past year compared to 4.0% at this time last year. Similarly, the core CPI has eased to a year-over-year pace of 3.4% versus 5.3% last May. Inflation appears to be back on a downward path after a Q1 spike, but there is still a bit more distance from its desired destination. Even with Wednesday's softer report for May inflation, the core CPI has increased at an annualized rate of 3.3% over the past three months.

The Producer Price Index also showed softer price pressures in May. Market participants closely watch the PPI, because some of its components are used as inputs in the PCE deflator, the latter being the Federal Reserve's preferred inflation metric. The PPI declined 0.2% in May, the biggest contraction since October 2023. Material declines in the PPI components for airfares and portfolio management as well as muted inflation in some health care sectors suggest that the May PCE deflator data also will be soft when the indicator is released on June 28. We estimate the headline PCE deflator increased a “low” 0.1% (0.06% unrounded) in May. We project the core PCE deflator increased 0.17%, which would reduce the three-month annualized rate to 3.0% and the year-over-year rate to 2.6%.

We cover this week's FOMC meeting in the Interest Rate Watch section of this report. In short, we think it will be a close call between one or two 25 bps rate cuts, and the FOMC seems evenly split between the two outcomes. This week's inflation data have increased our confidence that the jump in price growth in Q1 was a flare-up and not the start of something more sinister. We expect inflation to continue to grind lower as the year progresses, with enough of a slowdown by September that the FOMC feels confident enough to begin gradually normalizing the federal funds rate. Our base case forecast since early April has looked for a 25 bps rate cut at each of the September and December FOMC meetings. For now, our forecast remains two cuts this year and another 100 bps of easing in 2025 (chart).

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