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Headline inflation reaccelerated in the US for the second consecutive month, rising from 3.2% to 3.7% YoY.
Most of the uptick in inflation came from a well telegraphed uptick in energy prices, with over half of the 0.6% monthly increase stemming from gasoline prices alone. This won’t necessarily come as an immediate concern for the Fed, not unless the recent commodity rally persists and once again poses a credible threat of second round effects. However, the same can’t be said for core inflation, which increased for the first time in six months from an unrounded rate of 0.16% to 0.278% MoM, exceeding expectations of a 0.2% increase.
As we noted in our preview, the risk of an upward surprise to expectations was elevated given the pace of deflation in used car prices was set to slow based on auction price data, real time airline fare data had rebounded, and shelter inflation was set to continue its slow grind lower.
Overall, this is what transpired. The pace of deflation in used car prices slowed from -1.3% to -1.2% MoM, airline fares rebounded from -8.1% to 4.9% MoM, and shelter inflation dropped only marginally from 0.4% to 0.3% MoM. While there are reasons to believe that the current uptick in the sequential pace of inflation will be short-lived, one of which being that the bulk of the increase in core inflation occurred due to higher oil prices, and that should fade in coming months, policymakers at the Fed will be hesitant to roll out the transitory language once again. As such, we expect the Fed to retain its hawkish but data-dependent stance from Jackson Hole at next week’s meeting. This should keep the door ajar for a further hike in Q4 but not making it a foregone conclusion, while simultaneously weighing on market expectations of rate cuts in 2H24.
Markets whipsawed on the data as the readthrough for the Fed beyond September is murky
While the immediate market reaction to today’s core inflation beat was as expected – rate cuts in 2024 were priced out leading to a rally in front-end Treasury yields, the dollar caught a bid, and US equity futures plumbed fresh lows for the day–the sharp turnaround in price action shortly after led to some head scratching. In our view, the reversal was primarily driven by the fact that the bulk of the inflation beat occurred in gasoline sensitive components. In fact, the 2% monthly increase in transportation services accounted for more than the 12bps acceleration in the pace of core inflation from July.
Furthermore, the detailed component breakdown of August’s data didn’t send a consistent message that inflation pressures were broadly resurging, with cyclical components showing mixed monthly price gains.
Based on this along with the premise that these indirect energy effects will fade and the outlook that airfares will once again be discounted as consumer demand conditions cool, markets began to U-turn on their view on what today’s report means for the Fed’s policy path moving forward, with around 5bps of cuts for 2024 put back into the SOFR curve.
In our view, today’s inflation report does little to tip the balance for markets and credibly reintroduce a resumption in the Fed’s hiking cycle to the dominant dollar narrative. This should keep pricing of a Q4 rate hike at or below 50% and prevent the dollar DXY index from breaking fresh six month highs in the coming weeks.
Markets initially price out rate cuts in 2024 on core inflation beat, before swiftly reversing course
Author:
Simon Harvey, Head of FX Analysis