Rebound Potential of U.S. Core CPI

The recent trends in the U.S. core Consumer Price Index (CPI) suggest that it may have reached a bottom and is poised for a rebound. In May 2024, the core CPI decreased slightly year-over-year, which appeared to be below market expectations. However, deeper analysis reveals two key indicators pointing towards a forthcoming increase in inflation. This report aims to analyze these indicators and their implications for the U.S. economy, Federal Reserve policies, and broader financial markets.

Core CPI Performance Overview

Recent Performance:In May 2024, the U.S. core CPI decreased by 0.2 year-over-year to 3.4%, while the CPI dropped by 0.1% to 3.3%.
The core CPI rose by 0.2% month-on-month, slightly below market expectations, largely due to lower prices for durable goods and core services excluding rent.

Factors Indicating Potential Rebound

Energy Prices:

The recent decline in oil prices led to a 2.03% decrease in the energy component of the CPI. It also have direct influence to cost of production of durable goods, easing their inflationary pressure. However, recently, oil prices have stabilized after a period of rapid decline, which historically signals an end to deflationary pressures in energy-related sectors.

Labor Market and Wage Growth:

The U.S. labor market showed robust performance in May 2024, reversing the pause in April 2024, with strong non-farm employment data and accelerating wage growth. Nonfarm payrolls increased by 272,000 jobs last month as opposed to the 185000 forcast. Average hourly earnings rose 0.4% after having slowed to a 0.2% rate in April. Wages increased 4.1% in the 12 months through May following an upwardly revised 4.0% annual rise the prior month. This strong labor market performance suggests increased consumer spending capacity, which can translate into higher inflation.

ISM Manufacturing and Services Indices:

Both the ISM Manufacturing and Services indices have shown price components above the 50% line, indicating expansion.
The manufacturing price component has risen back above the 50% expansion zone, suggesting a reversal from previous contractions.
The services price index remains above the 50% line, reversing its previous downtrend, which underscores sustained inflationary pressures in the service sector.

Implications for Federal Reserve Policy

Interest Rate Projections:

The potential rebound in core CPI could lead to adjustments in the Federal Reserve’s interest rate policy. Currently, two rate cuts in September and December 2024 are considered the most rational choice.

An upward shift in core CPI could alter expectations regarding the Fed's rate cut path, impacting U.S. Treasury yields and the U.S. dollar index.
Market Expectations:

Rising core CPI might change market expectations about the Federal Reserve's monetary policy, influencing investor decisions and market dynamics.

Global Economic Comparisons

Monetary Policy Divergence:

Central banks in Europe, the UK, and Japan may accelerate rate cuts due to rapidly cooling consumer demand and rising deflationary pressures, contrasting with the potential path of the U.S. Federal Reserve.

This divergence in monetary policy could lead to further appreciation of the U.S. dollar index.

Impact on Global Trade:

The protectionist measures and tariffs introduced by the U.S. may influence global trade dynamics, affecting import and export prices and overall economic conditions.