US PPI data indicating stalled core disinflation in Q4 too

·         Fed may pause in Dec’24 not only for stalled core disinflation but also to analyze the impact of Trump’s policies on US price stability and employment

·         But if there is no major impact of Trump policies on inflation and employment, the Fed may continue to cut 25 bps every alternate meeting in 2025-26 and H1CY27

·         As per US core PPI and CPI data trend, the core PCE inflation may edge up to 2.8% in October from 2.7% sequentially

Wall Street Futures are wobbling in a roller coaster move amid escalated Ukraine war tensions & Russian ‘nuke’ rhetoric, mixed report cards, and hypes of Trump 2.0 politics & policies. The market is now concerned about a potential mini WW-III after Ukraine struck deep inside Russia with US-UK/French-made long-range ballistic missiles, while Russia also intensified its attack and now using experimental intermediate missiles.

On, 14th November, the focus of the market was also on US core PPI data, a day after core CPI data showed stalled core disinflation in October. 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) surged by 3.1% in October, from 2.6% sequentially, above the market consensus of 3.0% and still substantially higher than pre-COVID (December’19 levels of 1.3%. Overall, the correlation between core PPI and core CPI may be indicating after a brief pause in the last few quarters, pricing power for US retailers is again on the rise; i.e. US core disinflation pace may be stalling as already been evident from the actual data for the last few months.

Overall, unlike during pre-COVID times, core PPI and CPI disinflation were diverging 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 core CPI inflation and even core PCE 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 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% 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 surged 0.3% in October from a 0.2% increase in the previous month and is in line with the market expectations of a 0.3% increase.

 

Overall, after the latest 4M revision, the 2024 (YTD) average of core PPI is now around 2.6% in October vs prior 2.5% and against 2.9% in 2023, 7.8% in 2022, and pre-COVID levels around 1.5%; the 6M rolling average of US core PPI is now around 2.9% (vs earlier +2.7%). 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 2.4% in October from 1.9% reading sequentially, above market expectations of 2.3% and the highest since June’24, and still higher than pre-COVID (Dec’19) levels of 1.4% (against total CPI +2.3%; total PCE inflation +1.6%).

Overall, after the latest 4M revision, the YTM rolling average of US PPI was around 2.1% in October (before +2.0%) against the 2023 average of +2.0%. The 6M rolling average of the US PPI was around 2.3% against 2.2% The sequential rate (m/m) of the US PPI was around 0.3% in October against 0.1% in the prior month, in line with the market expectations of 0.2% and the 2024-YTM average 0.2%.

The US annual (y/y) super core PPI (without food, fuel/energy, and trade services) increased 3.5% in October’24 against 3.3% in the prior month and pre-COVID (December 19) levels 1.5%. The sequential (m/m) rate was 0.3% in October’24 against 0.1% in the prior month.

Overall US core and super core PPI as well as core PCE and core CPI disinflation may have stalled in October too after Q3. As per core CPI and PPI data trend, the sequential core PCE inflation for October’24 may come to around 0.3%; and the annual rate of US core PCE inflation should come around +2.8% in October’24 against +2.7% sequentially.

The core CPI for October 24 was at +3.3% and the average core inflation (PCE+CPI) would be around 3.1% against 3.0% in the prior month. In October, the 3-months rolling average of US core inflation (PCE+CPI) would be around 3.1%, while the unemployment rate 4.1%. As per the dual mandate of maximum employment and price stability, the Fed needs to ensure US core inflation is around 2.0% and the unemployment rate 4.0% on a sustainable over the medium term on an average for a goldilocks US economy. But the Fed also aspires 3.5% average unemployment run rate; i.e. 96.5% employment rate as the potential maximum employment for the US economy.

Thus Fed now needs to bring down average US core inflation (CPI+PCE) to around 2.0% from the present 3.1%, keeping the unemployment rate at least around 4.0%, if not 3.5%. But in the medium to longer term, say after 2-3 years, the Fed may also ensure an average US unemployment rate of around 3.5% from 4.0%, by keeping borrowing costs near neutral 3.0-2.50% as per evolving situation.

Conclusions:

As US core inflation almost stalled in H2CY24 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 too to frond load rate cuts 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.

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 in November for any cuts as the Fed may also want to see Trump 2.0 policies, especially immigration and threatened deportations, which may again tighten the labor market and boost inflation.

Fed Chair Powell may also pause in December’24 and resume cutting again from March’24 after analyzing/digesting potential Trump policies and also to keep President Trump in a ‘good mood’ by not cutting rates ‘unnecessarily too much’ under Biden Presidency.

Thus, apart from economic data issues, political compulsion may also Powell not to take such a huge risk and irritate Trump by going for an ‘unnecessary’ cut 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%; this will translate a real REPO rate +1.0%.

Bottom line:

Fed may pause in December’24 after cutting 75 bps cumulative in September and November’24. And then depending upon actual core inflation and employment trajectory, if there is no major surprise on any side, the Fed will gradually cut rates from March’24 for every alternate meeting (QTR end) till at least H1CY27. Fed may cut cumulative 100 bps each in 2025-26 and 59 bps in 2027 for a longer-term neutral repo rate of 3.00%. The market is still now discounting around 53% of the 25 bps Fed rate cut in December’24. Although it stumbled from around 85% in the last two weeks after less dovish Fed talks including comments by Powell, the Fed may ensure around 0% by December 1st week before going for blackout for the 18th December FOMC meeting. Thus Wall Street Futures and Gold may slip in the days ahead and the market/Fed will now focus on November NFP/BLS job data before the blackout period and also core inflation data during the blackout period.

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

Looking ahead, whatever the fundamental narrative, technically Dow Future (CMP: 44400) 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).