US core disinflation may stall in H2; Will Fed cut in Dec’24?

·         Wall Street and Gold slip as Fed Chair Powell almost poured cold water on December rate cut

·         October CPI and PPI data show last mile of core disinflation may have stalled in Q2CY24

Stimulus addicted Wall Street (US stocks) is now hovering around life lifetime on hopes & hopes of dual stimulus; President-elect Trump’s fiscal stimulus and also the Fed’s monetary stimulus. Fed is now cutting rates back-to-back as if the US economy has again fallen in the grip of another financial crisis (recession) after COVID. After holding rates for 13 months at +5.50% (from July’23 to Aug’24), the Fed suddenly began to panic after three months of rolling average (3MRA) of the US unemployment rate going above orange line 4.0% (against red line 4.5% and green line 3.5%).

In the 18th September’24 FOMC meeting, the Fed has access to core CPI and employment situation data till August’24. The 3MRA of unemployment rate in Augyst’24 was 4.2% and core CPI inflation 3.2%; the Fed needs to bring down core CPI to at least 2.3% levels and core PCE inflation around 1.5% for its 2.0%  average (CPI+PCE) core inflation target on a sustainable manner. Ideally, the Fed should have started the current rate cut cycle from the June quarter end when the 3MRA of the unemployment rate was 3.9% and core CPI 3.6% (up to May 24) by regular -25 bps each quarter end (every alternate meeting) rather than panic cut of -50 bps in September’24, followed by regular -25 bps in November’24.

Now the question is whether Fed will cut another -25 bps in December’24 for a cumulative cut of -100 bps in 2024 to stay ahead of the curve, followed by another -100 bps cumulative cuts in both 2025-26 for a longer term terminal repo rate +3.0% against average core inflation (CPI+PCE) just below +2.0% (~1.9%) and unemployment rate around 3.5% (maximum employment 95.5%). At present, the 3MRA of US core inflation is around +3.0%, while the unemployment rate is 4.1% (till October 24). Fed needs to dial back restrictive rate gradually to bring down average core inflation back to just below +2.0% in a predictable quarterly pace of -25 bps, keeping the unemployment rate at least at around 4.0% longer-term sustainable levels and then to 3.5% aspirational levels.

Thus Fed is now maintaining that risks on both sides are in balance as it has to bring down average core inflation by at least another 100 bps and the unemployment rate by 50 bps. Fed is also in QT mode, which is financial tightening, opposite to financial loosening (rate cuts). Fed is cutting rates and also doing QT in a calibrated manner to ensure financial or funding/money market stability and not to repeat the late 2019 money/funding market crisis (Trump 1.0) and launch rate cuts and mini QE even before COVID in 2020.

Fed is now increasing the QT pace to some extent to close the same by H1CY25 while cutting rates for every alternate meeting from 2025. At present despite cutting rates by 75 bps since September’24 and anticipating another 25 bps in December’24, the US10Y bond yield surged from around +3.60% in September’24 to almost +4.50% as the Fed is doing QT actively and Trumponomics 2.0 may increase US public debt by more than current trend rate. All these mean a higher and potentially higher supply of US bonds; thus bond prices are going lower and inversely proportional bond yields going higher.

Also Fed is ensuring real bond yield (10Y) does not go substantially above 1% from average core CPI inflation which is now around 3.5%; thus Fed may not allow US10Y bond substantially above +4.50% for the time being, which is now trading around +4.47%. Similarly, the Fed may not allow US10Y bond yield meaningfully below average core CPI inflation to ensure no negative real bond yield; the Fed is now ensuring moderate real positive bond yield (maximum +1.0%) to bring down core inflation around +2.0% targets from now around +3.0%, keeping unemployment rate stable around 4.) or even below that towards 3.5% by 2025-26.

As US core disinflation almost stalled in the last few months, the Fed may have to now focus on both core inflation and employment trajectory rather than too much emphasis on employment as we have seen in the last few months; the last mile of disinflation is always hard. Fed also gives priority to the price stability mandate, which is primarily to ensure sustainable maximum employment and is secondary to the Fed; without price stability, the economy does not work for anyone, even for the super riches. Price stability is fundamental to ensure sustainable inclusive economic growth and maximum employment; otherwise, there may be K-shaped economic growth and prosperity, which will create more inequality. The US Congress has not provided any official employment target as ‘maximum’ unlike the price stability target of core inflation at +2.0%.

Generally, the Fed and also US Congress maintain that under the current economic scenario, the maximum employment rate is 96.5% and minimum unemployment at around 3.5%, but the Fed also always maintains that a 4.0% average unemployment rate of a sustainable longer-term minimum unemployment rate or 96%; Fed also sees 4.5% average unemployment rate as red line. The Fed was also under huge pressure from the Wall Street stakeholders and also US Congress, especially from Democrat lawmakers/politicians ahead of the US election after the unemployment rate surged from around 3.5% in 2023 to above 4.0% in 2024.

On Wednesday, some focus of the market was on U.S. inflation data for October’24 as it may influence the Fed's decision for any rate cut action on 18th December’24. Fed will also consider the November’24 core inflation and employment report along with the overall 6-month rolling average (6MRA) of data.

On Wednesday, the BLS data (NSA) showed the annual (y/y) US core CPI inflation increased by +3.3% in October’24, unchanged from +3.3% sequentially; i.e. unchanged and in line with the market consensus of +3.3%. But the core CPI for October’24 is still substantially over December’19 (pre-COVID) and the Fed’s price stability targets for core CPI levels of +2.3%.

Overall, the average of US core CPI remains unchanged at +3.5% in 2024 (YTM) against +4.8% in 2023, and +6.2% in 2022, while the 6M rolling average was around +3.3% (y/y) in October, unchanged from the previous month and the 3M rolling average was around 3.3%, edged up from +3.2% in the prior month. As per the current run rate, if the Oct’24 core CPI sequential rate comes again around +0.2 or +0.30%, then the annual rate would be +3.4% or +3.5%; i.e. the US core disinflation pace may have slowed down or even stalled in Q4CY24 too; the 2024 annual average core CPI inflation may remain to be around +3.5%, still substantially higher than +2.3% Fed’s targets. As per current and projected sequential rate, the US core CPI inflation may come down to around +2.3% Fed targets by December’26.

The US core CPI needs to go down at least 1.0%  from present levels of +3.3 for the Fed’s price stability target of core CPI inflation around +2.3%, which is equivalent to core PCE inflation around +1.5%; the US core PCE inflation may be around +2.8% in October’24 and the 2024-YTM average would be around +2.8%. Fed needs core CPI and core PCE inflation around 2.3% and 1.5% so that overall average core inflation remains around +2.0% ((2.3+1.5)/2=1.9%~2.0%)).

And Fed also needs to keep the US unemployment rate at least around 4.0% on a durable basis for its maximum employment on a sustainable basis on an average for the longer term, but also aspires to keep it down around historically low unemployment levels of 3.5% (pre-COVID) for a dream combination of maximum unemployment and price stability.

On Wednesday, the BLS data (SA) also showed the sequential (m/m) US core CPI increased +0.3% in October’24 from +0.3% in the preceding month; i.e. unchanged, but in line with the market expectations of +0.3%. Fed needs an average sequential core CPI rate of around +0.2% consistently for 2.0-2.3% core CPI targets in the longer/medium term.

Overall, the 6MRA of US sequential core CPI was +0.2%, while the 3MRA was +0.3% and the 2024-YTM average was +0.3% against +0.3% in 2023 and +0.5% in 2024.

As per historical and present trend/rate, if the average sequential core CPI rate (NSA) remains around 0.2-0.3% in rest of CY24, CY25 and 0.2-0.1% in CY26, then the annual core CPI average would be around +2.3% by Dec’26; i.e. Fed may not achieve price stability targets of core CPI inflation around +2.3% on a durable basis before Dec’26 unless there is an unusual deflation/recession trend.

The U.S. Core service inflation (w/o energy service) edged up to +4.8% in October’24 from +4.7% sequentially and is still substantially above pre-COVID December’19 levels of 3.0%. The Fed is now closely focusing on core service inflation, which is still quite elevated and sticky led by Shelter/Housing inflation amid higher demand for housing an increasing number of immigrant workers (increasing population), and the legacy issue of lack of adequate supply of affordable housing in the US.

In October’24, the annual US core CPI inflation was boosted by apparel, medical care products & services, alcoholic beverages, tobacco & smoking products, shelter, and transportation services, while dragged by new vehicles, and used cars & trucks.

Unlike China, the US is unable to create affordable housing (PPP model/private/public), smart cities, and high-speed railways for the increasing population due to a lack of political bipartisan consensus between Democrats and Republicans. The US has been suffering long from political & policy paralysis to increase the supply capacity of the economy (both social and traditional infra) to meet increasing demand and balance inflation. Moreover, now homeowners are not ready to accept lower rent due to higher demand and higher borrowing costs (home/mortgage loans). And so far, President-Elect Trump’s election campaign promises didn’t share any meaningful plan to ensure more supply of affordable houses (like Democrats) as Trump may be more interested in the premium housing segment as Trump himself is a big building developer/promoter before becoming US President

In October’24, the US Shelter inflation was unchanged at +4.9% from +4.9% sequentially, but still substantially above pre-COVID (Dec’19) levels of +3.3%.

In October’24, the BLS data also shows the US super core CPI inflation (w/o food, fuel/energy, shelter/housing, used cars & trucks) edged down to +2.3% from +2.4% sequentially, and December’19 (pre-COVID price stability) levels of +1.7%.

 

On Thursday, the BLS data (NSA) shows the annual (y/y) US total CPI inflation edged up to +2.6% in October’24 from +2.4% sequentially, in line with the median forecasts of +2.6% and almost at December’19 pre-COVID & Fed target levels +2.3%.  The US food inflation also ticked up to +2.1%, while energy inflation also edged up to -4.9%. The US food inflation was around +1.8% in December’19 pre-COVID days, while energy inflation was around +3.4%.

Overall, the 6M rolling average (6MRA) of US CPI was +2.8% in October’24 against +2.8% in the prior month. The 3MRA of US CPI inflation was +2.5%. The 2024-YTM average US CPI was +3.0% against a yearly average of +4.1% in 2023; officially the US Congress has given Fed price stability mandate of 2.0% CPI on a sustainable basis; not core CPI or core PCE and even total PCE inflation. However, the Fed usually takes the average of core PCE and core CPI inflation for any policy stance as core inflation generally gives a fair picture of underlying inflation; also there is a difference of around 50-100 bps between core CPI and core PCE inflation. But ordinary Americans are now concerned with higher cost of living expenses, which is total CPI. Overall, the US total CPI is now around +22% higher than pre-COVID December’19 levels against the normal run rate of +10%. Higher cost of living and higher input costs for SMEs were some of the primary economic factors behind the anti-incumbent wave against the Biden-Harris admin and Trump’s win.

On Wednesday, the BLS data (SA) showed the sequential (m/m) US CPI edged up at +0.2% in Oct’’24 from +0.2% in the prior month (unchanged) and in line with market expectations of +0.2% advance. In October’24, the US sequential total CPI was boosted by shelter (+0.4%), accounting for over half of the monthly increase. Also, food prices went up 0.2% while energy costs were unchanged.

Overall, the 6MRA of US sequential CPI was +0.1%, while the 3MRA was +0.2% and the 2024-YTM average was +0.2% against +0.3% in 2023 and +0.5% in 2024.

Conclusions:

As US core inflation almost stalled in Q3CY24 around +3.0% on average, while the unemployment rate remains stable at around 4.0% along with resilient Real GDP and PDPF growths around 2.8-3.0% on average, the Fed may pause in December’24 to asses more data and Trump policies on inflation and employment.

As per Taylor’s modified rule, considering the desired real REPO rate of +1.0%, core CPI inflation targets of +2.3%, unemployment targets of 3.5%, and real GDP growth targets of 3.0% and expected 2024 average levels, the Fed should cut REPO rate from present +5.0% to 4.0% by Dec’25. But the Fed may cut -25 bps in Dec’24 despite core disinflation almost stalled in Q3CY24, while the unemployment rate remains stable around 4.0% and economic activity remains resilient.

Bottom line:

The projected Fed rate cut of 25 bps in Dec’24 may not be assured as US core disinflation may have stalled in Q4CY24 too, while average unemployment remains around 4.0%; Fed may also give a pause in Dec’24 even after favorable data for any cuts as Fed may also want to see Trump 2.0 policies. But Powell may not take such a huge risk and irritate Trump by going for a pause in December’24. Thus Fed may cut in December’24 and may continue to cut every alternate meeting (QTR end with a fresh SEP/Dot-plots) in 2025-26 to H1CY27 for a longer-term terminal repo rate around 3.0% against projected core inflation (CPI+PCE) around 2.0% for a real REPO rate +1.0%.

Market Impact:

On Wednesday, Wall Street got some boost on hopes & hypes of a Fed rate cut in December’24, but on Thursday, after the PPI data, Fed Chair Powell poured almost cold water on the December rate cut. Powell clarified that the last mile of core disinflation almost stalled and the Fed was not in a hurry to cut rates. Subsequently, both Wall Street Futures slip on fading hopes of another Fed rate cut in December’24.

Weekly-Technical trading levels: DJ-30, NQ-100, SPX-500, and Gold

Looking ahead, whatever the fundamental narrative, technically Dow Future (CMP: 44000) now has to sustain over 44800 for any further rally to 45000/45200-45500/46000 in the coming days; otherwise sustaining below 44750-44650, DJ-30 may again fall to 43900/43300-42600/41600 in the coming days.

Similarly, NQ-100 Future (21150) has to sustain over 21500 for a further rally to 21700/21900-22050/22500 and even 23000 levels in the coming days; otherwise, sustaining below 21450-21350, NQ-100 may again fall to 20950/20850-20500/20300 and 20000/19800-19650/19350 in the coming days.

Technically, SPX-500 (5750), now has to sustain over 5725 for any recovery to 5935/5950*-5975 and further rally to 6000/6050-6100/6150 in the coming days; otherwise, sustaining below 5700, may again fall to 5675/5650*-5600/5575*-5550/5500-5475/5450 and 5425/5390-5370/5300* and 5250/5100* and further 5050/4950*-4850/4750 in the coming days.

Technically, SPX-500 (CMP: 6000), now has to sustain over 6100 for any further rally to 6150/6200-6350/6500 in the coming days; otherwise, sustaining below 6075/6050, may again fall to 6000/5950-5900/5850 and 5675/5600-5550/5500 in the coming days.

Also, technically Gold (CMP: 2600) has to sustain over 2590-2575 for a recovery to 2635/2675-2700/2715 and further 2725/2750-2775/2795 in the coming days; otherwise sustaining below 2575, Gold may further fall to 2540/2500-2470/2450 in the coming days (depending upon Fed rate cuts,  Gaza/Ukraine war trajectory).