A Federal Reserve rate cut in September and another in December looks like a nearly sure thing after this week's consumer price index and producer price index data. The S&P 500 got climbed in Friday afternoon stock market action after PPI inflation overshot estimates but looked benign below the surface.
PPI Inflation
Producer prices for final demand rose 0.2% on the month, above +0.1% forecasts. The 12-month PPI inflation rate rose to 2.6% vs. forecasts of 2.3%.
Economists pay attention to a narrower measure of producer prices that factors out food, energy or trade services, which was unchanged from May, undercutting 0.2% estimates. Trade services prices reflect gross profit margins for distributors.
The overshoot for the PPI was tied to distributor margins. The Labor Department said that a 0.6% increase in services prices came from a 1.9% jump in margins. That was pulled higher by a 3.7% in margins for machinery and vehicle wholesaling.
Economists won't be too worried about distributor margins, because those price pressures won't last without stronger end-market demand. Other PPI prices that feed into the Fed's primary inflation rate looked more mixed for June but saw downward revisions for May.
PPI Impact On Key Fed Inflation Rate
The PPI is important because it provides the prices for categories that make up about one-third of the Fed's primary inflation rate, the core PCE price index, including health care services prices. The CPI accounts for two-thirds of core PCE price index components.
The PPI measure of inpatient services rose 0.4% in June, while outpatient care prices rose 0.2%. However, the overall increase in health care services prices for May was revised down to 0.5% from 0.8%, unadjusted for seasonality.
Air fares also could result in a bigger core PCE price index rise than the core CPI. The PPI measure of airline passenger services prices rose 1.1%. By contrast, the CPI measure tumbled 5% in June.
After the PPI and Thursday's CPI data, which showed just a 0.06% rise in prices in June, Bank of America economists expect a 0.17% rise in the core PCE price index. Goldman Sachs economists forecast a 0.19% monthly rise, leaving the 12-month core inflation rate at 2.6%.
Fed Pivot Is Here
Fed Chairman Jerome Powell said last week, "We are getting back on a disinflationary path," and the June CPI data provided more confirmation.
Core services prices rose just 0.1%, the least since August 2021, after May's tame 0.2% increase.
Overall shelter prices rose 0.2%, amid a 2.5% decline in hotel and motel rates. Still, 0.3% increases in primary rent and owner's equivalent rent also were the smallest increases since August 2021.
Goods prices fell 0.1% on the month and 1.8% from a year ago. Prices for new vehicles fell 0.2% from May and 0.9% from June 2023, the biggest year-over-year decline since May 2018.
As inflation ebbs toward the Fed's target, the labor market has cooled just about as much as the Fed wants it to.
Powell told Congress on Tuesday that the labor market "appears to be fully back in balance," meaning the supply of available workers roughly matches hiring demand. As a result, the labor market is "not a source of broad inflationary pressures for the economy now."
Fed Rate-Cut Outlook
With inflation gradually moving back to the Fed's 2% target, Nomura economist Aichi Amemiya and colleagues wrote on Thursday that "the pace of easing should remain limited to one 25bp cut per quarter as long as labor data remain resilient."
That suggests the Fed will cut its key interest rate by a quarter-point in September and again in December. However, given the softening labor-market trend, markets see a decent chance of a third rate cut this year.
After Friday's PPI data, markets are pricing in 94% odds of a rate cut at the Sept. 18 Fed meeting and 92% odds of at least 50 basis points in cuts by the end of 2024. Odds of three quarter-point rate cuts this year have climbed to 49% from 29% a week ago.
S&P 500
The S&P 500 rallied more than 1% to an intraday record, before settling for a 0.5% gain in Friday stock market action. Despite Thursday's Fed-friendly CPI report, the S&P 500 slipped 0.9% to end a seven-session winning streak. Through Friday, the S&P 500 has climbed 17.7% in 2024.
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