CICC: US inflation slowing supports Fed rate cut within the year

In June, the US CPI increased by 3.0% year-on-year (previously 3.3%), while the core CPI increased by 3.3% year-on-year (previously 3.4%), both showing a slowdown from the previous month and below market expectations. This data is well-received as it indicates a further cooling of inflation in the US. These figures will also strengthen the Fed's motivation to cut interest rates within the year, although the timing of the rate cut is still to be confirmed. Considering the stable US labor market and the expected accelerated fiscal expansion in the second half of the year according to CBO estimates, as well as the suspicion of an "overreaction" in the market's response to rate cuts, we are more cautious than the market regarding the timing of the rate cut. Without more and better data, we maintain our judgment that a rate cut will occur in the fourth quarter under baseline conditions.

Firstly, the slowdown in inflation in June is broad-based, with both overall and core CPI showing signs of deceleration. Looking at specific items, prices of new cars, used cars, furniture, appliances, computers, and other goods continued to decline, benefiting from supply chain improvements and possibly influenced by a structural shift in consumer demand from goods back to services post-pandemic. Rent inflation finally saw a slowdown in month-on-month growth rates. The seasonally adjusted month-on-month growth rates of primary residence rents and equivalent rents for owners decreased from 0.4% to 0.3%, but due to a 2.5% decline in hotel prices, the overall subcategory growth rate for rents was pushed down to 0.2%. The Fed's most closely watched non-rent core services inflation (supercore) continued to decelerate for the second consecutive month, with a month-on-month growth rate dropping from zero growth in May to -0.1% in June. Airfare prices, after a 3.6% decline last month, further plummeted by 5.0%. Subcategories such as hospital services, entertainment services, and courier services also saw growth rates turning negative. The increase in immigration to the US since last year has led to a cooling of the labor market, which has also played a role in reducing service inflation.

Secondly, this set of inflation data will strengthen the Fed's motivation to cut interest rates within the year, but the timing of the rate cut is still pending confirmation. Powell stated during his congressional testimony this week that the US labor market has cooled down and progress has been made in inflation, but a rate cut still requires seeing "more good data." The latest inflation data released on July 11 is considered good data, thus boosting the Fed's confidence in cutting rates. However, there are still two months until the September FOMC meeting, with two sets of inflation and employment data to be released during this period. We believe the Fed will observe more data before making a decision, rather than prematurely providing loose guidance as they did at the end of last year, which ultimately backfired.

Thirdly, the US labor market remains robust, and combined with the expected accelerated fiscal expansion in the second half of the year according to CBO estimates, it may once again dampen rate cut expectations. Regarding the labor market, the rise in the unemployment rate in June has raised concerns about deteriorating employment, prompting the Fed to cut rates sooner rather than later. However, we believe the increase in the unemployment rate is mainly due to more people entering the labor market rather than significant deterioration in demand. In other words, the rise in the unemployment rate is due to an increase in supply rather than a sharp decline in demand, so we believe there is a high probability that we will not see a "non-linear increase" in the unemployment rate. Additionally, the number of initial jobless claims announced today unexpectedly dropped to 222,000 people, a significant decrease of 17,000 people from the previous week, indicating that the labor market remains healthy On the fiscal front, the Congressional Budget Office (CBO) recently raised its forecast for the deficit rate in the 2024 fiscal year from the initial prediction of 5.3% to 6.7%, an increase of 1.4 percentage points. According to the CBO's forecast, the total deficit for the 2024 fiscal year is expected to be around $1.9 trillion, equivalent to a monthly deficit of about $159 billion. In the first 8 months (from October 2023 to May 2024), the monthly deficit was around $150 billion, a year-on-year increase of 3.2%, while in the last 4 months (from June to September 2024), it was around $178 billion, a year-on-year increase of 34.5%. This suggests that fiscal spending in the third quarter of this year is expected to accelerate, providing additional support to economic growth, and interest rate cut expectations may be suppressed as a result.

According to CME data, the current market pricing for a rate cut in September exceeds 80%, but there are still two sets of employment and inflation data to be observed in July and August before the September FOMC meeting, hence there is still uncertainty. In fact, there has always been suspicion of market "overreaction" to rate cuts, with people always hoping to "front-run" rate cuts. In early January this year, the market pricing for a rate cut in March by the Fed reached as high as 75%, and the pricing for the number of rate cuts for the whole year even reached 6 to 7 times, but none of this materialized in the end. Therefore, we believe that more data observation is needed, and based on the existing data alone, we still maintain the judgment of a single rate cut under baseline conditions, with the timing in the fourth quarter.

Chart 1: Core inflation in the United States has been slowing down over the past three months

Chart 2: Gasoline prices fell, putting pressure on June inflation, but have rebounded recently

Chart 3: Significant volatility in non-rent core service inflation fluctuations

Source: Haver, CICC Research Department

Data Source: Haver, CICC Research Department

Chart 4: Airfare prices drop to levels seen during the pandemic disruption

Data Source: Haver, CICC Research Department

Authors: Xiao Jiewen, Zhang Wenlang from CICC, Source: CICC Insight, Original Title: "CICC: US inflation slowdown supports Fed rate cut within the year"

Xiao Jiewen Analyst SAC License No.: S0080523060021

Zhang Wenlang Analyst SAC License No.: S0080520080009 SFC CE Ref: BFE988