US PPI and CPI data indicate stalled core disinflation in Q4

·         But despite unfavorable data and Trump policy uncertainty, the Fed may cut 25 bps next week for a cumulative 100 bps cut in 2024 and a repo rate of 4.50%

·         Fed may keep core real repo rate around +1.00% going forward against +2.00% in H1CY24 and thus continue to cut 25 bps every alternate meeting till June’26 for a repo rate of 3.00%

·         Fed has to also catch up with synchronized global easing to avoid unwanted USD strength, especially with the ECB which is panicking to deal with a potential Trump trade war 2.0 and devaluing EUR

On Thursday (12th December), some focus of the market was also on US core PPI data, a day after hotter-than-expected US core CPI data. Fed officially 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 of every month. The market usually has an idea about the possible rate of core PCE inflation data after getting core CPI and core PPI data mid-month.

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 Thursday, the BLS flash data (NSA) showed annual (y/y) U.S. core PPI (w/o food & energy) surged by +3.4% in November, from +3.4% sequentially, above the market consensus of 3.2% and 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 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 2.8% in November vs prior 2.6% in the prior report and against 2.9% in 2023, 7.8% in 2022, and pre-COVID levels around 1.5%. In November’24, the 6M rolling average of US core PPI is now around 3.1% (vs earlier +2.9%), while the 3M rolling average was around +3.3%. 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 +3.0% in November from +2.6% reading sequentially, above market expectations of 2.6% 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 YTM rolling average of US PPI was around 2.2% in November vs +2.1% in the prior report against the 2023 average of +2.0%. The 6M/3M rolling average of the US PPI was around 2.5% against 2.3%. 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 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 +0.3% in November, which would translate to +3.0% against October’24 reading of +2.8% and +2.7% in July-September’24.

Conclusions:

As US core inflation (CPI+PCE) almost stalled or even edged up in H2CY24 around +3.0% on average, while the unemployment rate remains stable at around 4.0% along with resilient Real GDP and PDPF growth around 2.9% on average, the Fed should pause in December’24. But the market is now still expecting a -25 bps rate cut on 18th December as the Fed may have missed the opportunity of two rate cuts in H1CY24. Thus to make up, the Fed may also cut -25 bps in December’24 for a cumulative -100 bps cut in CY24 (by front-loading to stay ahead of the curve). Fed has to also synchronize with BOC, ECB, BOE, SNB and various other European and APC central banks, most of which are in rate-cutting sprees like in a crisis to avert a looming stagflation or even an all-out recession.

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.

Ideally, 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%. Thus the Fed may also give a pause in Dec’24 as the Fed may also want to see Trump 2.0 policies, especially on immigration and tariffs, both of which may affect US price stability (inflation) and the goldilocks labor market. Thus for the last few weeks, the Fed was also actively trying to talk down the implied market probability of a rate cut, but after some downward move, it again surged to almost 100%. Usually, the Fed never takes any rate action without keeping the market into confidence to avoid disorderly market movement or an unusual volatility.

Thus despite supportive data including November core PPI data indicating stalled core PCE disinflation for November/Q4CY24, and other reasons (need time to assess actual Trump policies), the Fed may cut 25 bps in December’24 if it did not try to talk down (indirect in the blackout period) the rate cut probability at least below 80-50%  in the last days.

Thus the Fed may 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 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.

Bottom line:

Despite unfavorable data, and Trump policy uncertainty Fed may 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. 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 alternate meeting till June’26 for a repo rate of +3.00% from +4.75% at present.

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

Looking ahead, whatever the fundamental narrative, technically Dow Future (CMP: 45100) now has to sustain over 45500 for any further rally to 45800/46000-46200/46400 and 46800/47000-47500/48000 in the coming days; otherwise sustaining below 45450/45200, DJ-30 may again fall to 45000/44750-44650/44200, DJ-30 may again fall to 43900/43300-42600/41600 in the coming days.

Similarly, NQ-100 Future (21450) has to sustain over 21200 for a further boost to 21500 and further to 21700/21900-22050/22500 and even 21450 levels in the coming days; otherwise, sustaining below 21150, NQ-100 may again fall to 20950/20850-20500/20300 and 20000/19800-19650/19350 in the coming days.

Technically, SPX-500 (CMP: 6050), 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: 2650) has to sustain over 2680 for a recovery to 2700-2725 and further 2735/2750-2775/2795 and 2815 in the coming days; otherwise sustaining below 2655-2630 may again fall to 2605/2600 and 2590/2565 and further fall to 2550/2500-2470/2450 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 $2100 levels if Trump indeed can mediate both Gaza and Ukraine war ceasefire by early 2025.