US PPI & CPI data indicating 2.7% core PCE inflation for Dec

·       Overall 2024 & 3MRA of core PCE inflation would be around 2.8% against the Fed’s real target/Dec’19 pre-COVID levels of 1.5%; the Fed may be on hold in Q1CY25

·       On early Tuesday, Wall Street Futures were almost flat despite Nvidia recovering to some extent from Chinese GAI start-up DeepSeek panic low

·       Boeing helped on upbeat guidance despite a terrible report card, while Lockheed Martin plunged on earnings miss

On, 14th Jan’25, the focus of the market was also on US core PPI data, a day after softer core CPI data. Fed primarily follows core PCE inflation, data of which is published generally around the last week, while core CPI and PPI data are published around mid-month. The market usually has an idea about the potential rate of core PCE inflation after getting core CPI and core PPI data mid-month. In that sense, core PCE inflation data may be now turned into a lagging indicator.

The US Producer Price Index (PPI) for final demand measures price (production cost) index change for commodities sold for personal consumption, capital investment, government, and export. It is composed of six main price indexes: final demand goods (33% of the total weight), which includes food and energy; final demand trade services (20%); final demand transportation and warehousing services (4%); final demand services less trade, transportation, and warehousing (41%); final demand construction (2%); and overall final demand; Goods: This includes prices for raw materials and finished products (e.g., steel, lumber, cars); Services: This includes sectors like transportation, healthcare, and finance; Construction: Prices in this sector, like those for residential and non-residential buildings.

The Producer Price Index (PPI) is a key economic indicator that measures the average change over time in the prices that domestic producers receive for their goods & services and reflects inflation from the perspective of producers/whole sellers rather than consumers (which is measured by the Consumer Price Index or CPI). The PPI tracks prices at the wholesale level before they reach the consumer. It covers a wide range of industries, including manufacturing, agriculture, mining, and services. The PPI is vital for understanding inflationary pressures within the economy. It helps businesses and policymakers make informed decisions regarding pricing strategies/power, wage negotiations, and monetary policy adjustments.

On Tuesday, the BLS flash data (NSA) showed annual (y/y) U.S. core PPI (w/o food & energy) increased by 3.5% in Dec’24, from 3.5% sequentially, lower than the market consensus of 3.8%, but the sharpest increase since Feb’23. And the US core PPI is still substantially higher than pre-COVID (December’19 levels of 1.3%. The historical correlation between core PPI and core CPI/PCE inflation now may show that as input costs are increasing for producers, they have now no option but to pass it to retailers and eventually to consumers. Whenever the US core PPI has gone above core CPI and PCE inflation persistently, it results in higher core inflation in the subsequent months.

Overall, unlike during pre-COVID times, core PPI is now increasing due to various structural reasons including supply chain issues, corporate greedflation, and adequate pricing power as there is still elevated demand in the economy amid a growing population and robust labor market, while supply capacity is still constrained.

Now latest core PPI data may also be indicating not only stalled core PPI disinflation but also increasing producer price or input cost inflation. This is in turn causing stalled/higher core inflation. And if this trend of higher producer price inflation continues, then we see higher core or even retail (total) inflation. As demand is still higher than the supply capacity of the economy, both producers and retailers have still some pricing power to increase prices.

Overall, the Fed needs a core PPI annual rate of around 1.3%, core PCE inflation of around 1.5%, and core CPI inflation of around 2.3% for its price stability mandate of 2.0% core inflation (~1.9%) on a sustainable basis. Although officially Fed maintains core PCE inflation sustainable at around 2.0% as its price stability mandate, in reality, it maintains an average of core CPI and PCE inflation of 2.0% as price stability in a sustainable manner.

The US core PCE inflation is consumption-based, while core CPI inflation is production, and thus core PCE is not a standard gauze of regular inflation in its true sense; the textbook standard is always core CPI inflation (without food and fuel), The core PCE inflation is usually lower than core CPI inflation by around 1.0-0.8% and it’s more aligned to core PPI inflation. Thus the market always looks at the core PPI sequential rate and also the core CPI sequential for an estimate of core PCE inflation. On a sequential (m/m) basis (SA), the U.S. core PPI was unchanged at 0.0% in Dec’24 from a 0.2% increase in the previous month and lower than the market expectations of a 0.2% increase.

On Thursday, the BLS flash data (NSA) also shows U.S. annual (y/y) total PPI increased by +3.3% in Dec’24 from +3.0% reading sequentially, below market expectations of 3.4% and the highest since Feb’23, and also still substantially higher than pre-COVID (Dec’19) levels of 1.4% (against total CPI +2.3%; total PCE inflation +1.6% price-stability targets).

 

Overall, after the latest 4M revision, the 2024 average of core PPI is now around 2.8% against 2.9% in 2023, 7.8% in 2022, and pre-COVID levels around 1.5%. On Dec’24, the 3M rolling average was around +3.5%. The average sequential (m/m) rate of the US core PPI is now at 0.3% against +0.1% in 2023. As per the pre-COVID longer-term trend, the Fed needs a +0.1% core sequential core PPI rate on a sustainable basis for its target/pre-COVID levels of 1.50%.

On Thursday, the BLS flash data (NSA) also shows U.S. annual (y/y) total PPI increased by +3.3% in Dec’24 from +3.0% reading sequentially, lower than the market expectations of 3.4%, but the highest since Feb’23, and also still substantially higher than pre-COVID (Dec’19) levels of 1.4% (against total CPI +2.3%; total PCE inflation +1.6% price-stability targets).

Overall, after the latest 4M revision, the 2024 average of US PPI was around 2.3% in November against the 2023 average of +2.0%. The 3M rolling average of the US PPI was around 3.0% against 3.0%. The sequential rate (m/m) of the US PPI was around 0.2% in Dec’24 against 0.2% in the prior month, in line with the market expectations of 0.2% and the 2024 average of 0.3%.

 

As per the underlying trend of core PCE and also core CPI data, the sequential rate of core PCE inflation may be around +0.0% in Dec’24, which would translate to +2.7% against the reading of +2.8% sequentially and +2.8% average for 2024 vs +4.2% in 2023 and pre-COVID (Dec’19) Fed’s target levels of +1.5%.

Conclusions:

Although the Fed generally talks about 2.0% PCE inflation as a price stability target, in reality, it maintains 1.5% core/total PCE inflation and 2.3% core/total CPI inflation; i.e. around 1.9% average inflation (PCE+CPI) targets, Congress has entrusted along with maximum employment 96.0-95.5% of the labor force; i.e. 4.0-3.5% headline unemployment rate. Fed will now try to bring down average core inflation from around 3.0% to 2.5% by keeping the unemployment rate at least around 4.0% by December’25 and then 2.0% core inflation and 3.5% unemployment rate by December’26 to achieve its mandate of maximum employment and price stability.

As US core inflation almost stalled in H2CY24 at around +3.3% on average, while the unemployment rate remains stable at around 4.2% along with resilient Real GDP and PDPF growths around 2.8-3.0% on average, the Fed should have paused in December to asses more data and Trump policies on inflation and employment. But the Fed cut -25 bps in Dec’24 too (after September and November) to make up for previous policy mistakes and be able to be ahead of the curve despite core disinflation almost stalled in H2CY24, while the unemployment rate remains stable around 4.0% and economic activity remains resilient.

Despite unfavorable data, and Trump policy uncertainty Fed cut on 18th December’24 to catch up with synchronized global easing and also to keep differential with ECB, which cut -100 bps in 2024. Fed may have also made a policy mistake by not cutting rates by 50 bps in H1CY24 and thus now cutting 100 bps in H1CY24 to catch up.

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 +4.50% to 4.00% by Dec’25. Fed may like to keep the repo rate at 4.5% against average core CPI inflation for 2024 around 3.5% for a real repo rate +1.0%, moderately restrictive, but lower than 2.0% in H1CY24, when the repo rate was 5.50% against average core CPI inflation +3.5%. Looking ahead, the Fed may like to keep the core real rate around +1.00% and cut gradually every six months till Dec’27 for a repo rate of +3.00% from +4.50% at present.

Thus the Fed cut on 18th December for a cumulative rate cut of 100 bps in 2024 to a repo rate of 4.50% against the average core CPI of 3.5% for 2024, so that the real repo rate remains around +1.00%. Fed may have made a policy mistake by not cutting from H1CY24 when 3MRA of core CPI was around +3.5% on average. Thus Fed is now cutting 50 bps extra in H2CY24 to stay ahead of the curve.

But despite a 50 bps projected rate cut in 2025-26, the Fed may cut 75-100 bps each if Trump’s immigration and tariff policies are less hawkish in reality due to moderate Musk & Co., who may ensure good relations between Trump/US with China and Russia (Putin); Musk has not only good business relation with China but also a good ‘personal/diplomatic’ relation with Putin for the last few years.

Fed front-loaded 50 bps rate cuts for 2025 in H2CY24 and thus may cut only 50 bps in 2026. But the Fed may also change its stance in the coming months and go for 100 bps rate cuts in 2025 if the US unemployment rate ticked up towards 4.5%, while core CPI inflation ticked down below +3.0%. We have to keep in mind Fed often changes its goalposts to suit its narrative/stance/rate action even after contradictory jawboning. The Fed should maintain more credibility as the Fed is the de-facto central bank of the world and controls almost all types of financial asset classes, with USD being the undisputed preferred global trade & reserve currency.

In H1CY25, the Fed may also share some concrete plans to end the QT, which may be positive for UST and negative for US bond yields, USD. Fed is now cutting rates while doing QT, which is two contra monetary policy tools. As a result, bond yields remain elevated at around 4.50% and the real economy may not be getting the full effect of a 100 bps rate cut in 2024. The market usually discounts Fed rate cuts well in advance in line with regular Fed talks and official dot plots.

Thus Fed may close the QT first by June’25 at B/S size around $6.60-6.50T from present levels of around $6.89T. Fed may keep the B/S size around 22% of projected nominal GDP around $30T by 2025, which may be an ideal level for the Goldilocks nature of the US economy and may not cause another REPO/Funding market crisis as we have seen late 2019 under Trump and Powell-1.0.

Bottom line:

Fed may first close QT by June’25 and then resume the rate cut cycle for 50 bps cumulative in 2025. But the Fed also changes its narrative/goalposts quite frequently and thus its credibility is now at stake. Overall, the Fed now has to bring core inflation (PCE+CPI average) from present levels of 3.3% to 2.3% and unemployment rate from the present average of around 4.2% to 3.5% by Dec’27 to declare victory for its dual mandate of minimum price stability and maximum employment.

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

Looking ahead, whatever the fundamental narrative, technically Dow Future (CMP: 44900) now has to sustain over 45300-45600 for any further rally in the coming days; otherwise sustaining below 45200-45000, DJ-30 may again fall to 44200/43900-43600/43200 and 43000/42700-42200/42000 in the coming days.

Similarly, NQ-100 Future (21000) has to sustain over 20700-21000 for recovery and rally to 21500/21900-22250/222500 and further 22700-23000/23300 in the coming days; otherwise, sustaining below 20700, NQ-100 may further fall to 20500/20300-20100/19250 in the coming days.

Technically, SPX-500 (CMP: 6049), now has to sustain over 5950 for any further recovery/rally to 6025/6050-6150/6200 and 6350/6500 in the coming days; otherwise, sustaining below 5925-5900, SPX-500 may further fall to 5800-5775 and 5700/5600-5475 in the coming days.

Also, technically Gold (CMP: 2690) has to sustain over 2705 for a further rally to 2725 and further 2740/2750-2775/2795 and 2815 in the coming days; otherwise sustaining below 2700-2685 may again fall to 2655/2620-2605/2600 and 2595/2575-2535/2435 in the coming days (depending upon Fed rate cuts, Gaza/Ukraine war trajectory); Gold surged almost 75% in the last one year since Gaza war started back in October’23. Now it may retrace to $2500-2400 levels if Trump indeed can mediate both the Gaza and Ukraine war ceasefire by early 2025.