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    Instant Insights: CPI facing resistance against further falls

    Instant Insights: CPI facing resistance against further falls

    August 11, 2023 Fixed income
    • Headline CPI slightly rises on base effects, but core CPI continues to make progress
    • Core goods and services both slow, with used cars and airfares contributing most negatively
    • Shelter and “supercore” CPI are the weakest elements of the report, but we believe they are still on a disinflationary trend

    Nominal CPI increased from 3% year-on-year last month, to 3.2% in July, but slightly lower than the 3.3% expected by the market. As we projected, this was the first rise since its peak level (of 9%) in June 2022.

    Importantly, Core CPI continued to make progress, albeit at a slower pace than last month, slowing from 4.8% year-on-year to 4.7% year-on-year (in line with expectations).

    Base effects run out, pushing nominal CPI up slightly

    Headline CPI continued to reflect disinflation across all the main categories. However, as we reached peak “base effects” last month, the energy component of the index fell by less year-on-year than it did in June (Figure 1).

    Figure 1: Base effects dissipate, stemming continued falls in nominal CPI

    Base effects dissipate

    Source: Bureau of Labor Statistics, Insight calculations, St Louis Fed, August 2023

    Core CPI continues to move in the right direction, albeit slowly

    The CPI core index, by contrast, is not set to face “peak base effects” until September. Core goods and core service components continued to ease (albeit the weighed contribution of the latter increased slightly), with the Fed’s hiking activity continuing to stem demand (Figure 2).

    Figure 2: “Sticky” services sectors continue to make progress

    Core CPI continues to move in the right direction, albeit slowly

    Source: Bureau of Labor Statistics, Insight calculations, St Louis Fed, Bloomberg, August 2023

    On the goods side, most core components had a neutral to negative contribution. Used vehicles (which contributes ~13% to core goods), was the second-largest negative contributor in the entire index, falling 1.3% month-on-month after falling 0.5% last month. The component may continue to retreat over the next two months, based on continued slowdown in the Manheim Used Vehicle Index1, which is a leading indicator.

    Core services inflation also continued to trend down. Airline fares were the largest negative contributor across the entire index, falling 8.1% month-on-month, and declining for the fourth consecutive month. Demand pressure for domestic (though not international) flights has been flagged by domestic airliners such as Jet Blue, Alaska Air and Southwest Airlines2 during recent earnings calls.

    Shelter (which contributes ~30%), was relatively sticky, holding steady on a month-on-month basis at 0.4% with the owners’ equivalent rent measure accelerating slightly from 0.4% to 0.5%. Nonetheless, we expect gradual deceleration to continue over the coming months given the CPI’s calculation methodology. Earlier this week, the San Francisco Fed projected shelter CPI will fall gradually from ~8% year-on-year to flat or negative by May next year, albeit the analysis ignores recent housing market resilience and relies on predominantly pandemic era data, so we would be slightly cautious. The Fed’s “supercore” was similarly sticky.

    There are finally signs that the Fed’s policy is loosening labor market conditions. For example, job openings fell to the lowest level since May 2021, and the pace of job creation has moderated over several months. This is having a knock-on effect on wage growth, which is running at the slowest level since June 2021. Momentum, measured by the 3-month annualized rate, is also slowing.

    Recent energy price rises are worth keeping an eye on

    Although energy has contributed negatively in recent months, WTI crude prices have advanced to their highest levels since November, partly reflecting Saudi Arabia’s commitment last week to extend production cuts by an additional month and heightened tensions in the Black Sea.

    If elevated prices hold through August, we expect energy CPI to contribute positively next month on a month-on-month basis, a break from mostly neutral or negatively contributions over the last 12 months (Figure 3).

    Figure 3: Oil price may contribute positively to CPI next month if prices hold

    Recent energy price rises

    Source: Bloomberg, American Automobile Association, Bureau of Labor Statistics, Insight calculations, August 2023

    The Fed has made progress, but it may be a bumpy road to 2%

    The path to 2% nominal will be bumpy. Disinflation in some service sectors will be slow. Further, energy has the potential to be somewhat disruptive and medical insurance (which is calculated in the CPI based on an annual calculation adjustment) will likely begin contributing slightly unfavorably from October, having been a tailwind over the last year.  

    However, for now the risks of inflationspiralling higherappear to have fallen, so we expect headline CPI to remain around the ~3% level for the coming months.

    We expect the Fed will take some comfort from Core CPI, which is making consistent, albeit slow, progress. There will be another print before the FOMC next meets in September, depending on the outcome, we currently expect the committee is biased toward holding rates steady.

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