Song Xuetao: "Rate Cut Trade" may not be as you see it

In June, broad-based cooling was seen in US inflation, with CPI month-on-month experiencing its first negative growth (-0.06%) since July 2022, mainly dragged down by energy and vehicle components, which collectively lowered CPI by 0.18 percentage points. CPI year-on-year fell from 3.27% in May to 2.97%. Core CPI month-on-month was driven by a significant cooling in housing inflation, slowing down by 0.1 percentage points to 0.06% from May, marking the slowest growth rate since January 2021. Core CPI year-on-year dropped from 3.42% in May to 3.27% in June.

This "anti-inflation" report may seem perfect, but the actual probability of a "rate cut trade" it triggers may not be as straightforward as it appears.

The first reason is that the post-pandemic inflation seasonal adjustment factor may have exaggerated the extent of the slowdown in core inflation month-on-month.

In 2019, the highest value of the seasonal adjustment factor used in the US appeared in April, with a clear summer effect. After the pandemic, the highest value of the seasonal adjustment factor was pushed back to June, with less obvious summer effects, appearing smoother. The reason behind this is the post-pandemic misalignment rotation repair of US goods and services consumption, leading to the seasonal effects before the pandemic no longer being obvious. Although the US real economy is no longer affected by the pandemic, the seasonal adjustment factor still retains the "memory" of economic activities during the pandemic by referencing data from the past 5 years.

If the pre-pandemic seasonal adjustment factor is used to "fit" the recent core inflation in the past few months, then the core CPI month-on-month for April, May, and June will become 0.25%, 0.23%, and 0.17%, respectively. Although cooling, it is more moderate, and a month-on-month increase of 0.17% is also more consistent with pre-pandemic average levels.

The second reason is that oil, vehicles, and housing—the three main reasons for the slowdown in inflation—do not necessarily reflect weakening demand.

WTI crude oil prices started to rise in mid-June, but the transmission of crude oil prices to gasoline prices lags, leading to a too noticeable 2.04% month-on-month decline in energy prices in June.

Travel demand directly related to energy consumption remains strong, with the number of travelers passing through the US TSA exceeding 3 million in a single day for the first time in history, and year-on-year growth rates are also recovering month by month. The same-store sales index for the US restaurant industry, as reported by the National Restaurant Association, has been steadily recovering since 2024

The decline in car prices has a significant impact on CPI, but in 2024, vehicle sales in the United States have not weakened. The reason for the decline in car prices is still due to dealers replenishing inventory and competing for market share by trading price for volume.

Another area that has cooled down significantly is housing inflation, with a month-on-month growth rate nearly halved, dropping from 0.39% in May to 0.20%. This is mainly due to the decline in primary residence rents and owners' equivalent rents to 0.26% and 0.28%, respectively, stepping down from previous levels.

Although the slowdown in housing inflation on a month-on-month basis is relatively certain, the data does not show a lagging slow cooling trend, but a rapid decline, casting doubt on the future trend. At the same time, the growth rate of U.S. house prices still maintains a stable lead over CPI housing inflation, indicating a turning point in U.S. housing inflation on a year-on-year basis around June, hence a possible rebound in housing inflation on a year-on-year basis in the third quarter.

The third reason is that the current labor market remains robust, and inflationary pressures will increase month by month.

The number of initial jobless claims released along with CPI also fell more than expected, with initial claims dropping and continued claims remaining around 4% year-on-year. Looking at non-seasonally adjusted data, the current number of unemployed people in the United States is not particularly high. As we pointed out in "The U.S. is Experiencing a Disconnect in Employment and Unemployment Data":

The current U.S. labor market is different from previous recession cycles (2000, 2008), as the rise in unemployment rate has not been accompanied by a decline in employment rate.

In addition, considering that the year-on-year inflation rate in the United States started to decline after entering the fourth quarter of 2023, it is also important not to overlook the tailwind effect caused by the dissipating base effect at the end of this year, which will push up the inflation level at the end of this year.

In a relatively stable economic environment, the Fed finds it difficult to grasp the timing of so-called "preventive" rate cuts. Especially when the actual wages in the United States have not been damaged, cutting interest rates will only further increase rather than reduce Americans' consumption tendencies; considering that the actual wage growth rate in the United States has been positive for the 13th consecutive month, this will bring greater inflationary pressure.

After the first round of televised debates, the uncertainty of the U.S. presidential election has further increased. If the Federal Reserve does not want to become the focus of heated discussions after the election, maintaining a low profile and reducing intervention is a better choice.