6/14/24 - May Inflation Data: CPI Unchanged, PPI Declines, Fed Maintains Cautious Stance

Following last week's strong employment report, investors shifted their focus to the latest inflation data. In May, U.S. consumers saw a reprieve from rising prices, with the Consumer Price Index (CPI) remaining unchanged month-over-month, the calmest reading since mid-2022. Essentials like groceries, gasoline, and car insurance saw reductions. Gasoline prices fell by 3.6%, the most significant drop since November, and motor vehicle insurance costs decreased for the first time since 2021. Energy costs moderated, with steady electricity prices and declining natural gas costs. The core CPI, excluding volatile food and energy prices, rose by just 0.2% month-over-month, less than expected. Producer prices followed suit, with the Producer Price Index (PPI) declining by 0.2% in May, the largest decrease in seven months. The PPI for final demand increased by 2.2% year-over-year, indicating a broad cooling in inflationary pressures. Several components of the PPI used to calculate the Fed's preferred inflation measure, the personal consumption expenditures (PCE) price index, softened in May, suggesting a similar trend in the PCE report to be released later this month.

Despite these promising signs, the Federal Reserve remains cautious. At the conclusion of its meeting this week, the Federal Open Market Committee (FOMC) decided to keep the federal funds rate steady at 5.25%-5.50% for the seventh consecutive meeting, emphasizing the need to see sustained evidence of easing inflation before considering any rate cuts. The FOMC's latest projections now suggest only one interest rate cut in 2024, with four more cuts expected in 2025. The Committee reiterated that it would not reduce the federal funds target range until inflation moves sustainably toward its 2% goal. Additionally, the Fed continues to reduce its holdings of U.S. Treasury securities and agency mortgage-backed securities as per its predefined schedule of $25 billion and $35 billion per month.

Financial markets reacted positively to the economic releases and the Fed's current policy stance. As of this morning, Treasury yields declined, with the two-year yield dipping to 4.70% and the 10-year yield to 4.22%. Stocks also rose, with the S&P 500 increasing by 1.28%. Cooling inflation could support higher stock valuations as cost pressures ease, though the Fed's reluctance to cut rates soon might temper short-term bullish sentiment. For bonds, lower inflation and stable interest rates have resulted in consistent returns, making them more attractive to investors seeking stability and income. Overall, the market's reaction suggests cautious optimism as investors balance current conditions with future expectations.

While recent data suggests cooling inflation, the Federal Reserve remains vigilant, maintaining its current policy until it is confident inflation is on a sustainable trajectory. This measured approach seeks to balance economic growth with price stability, influencing both stock and bond markets as investors recalibrate their strategies. We anticipate the Fed aims for a soft landing for the U.S. economy, characterized by slower yet positive growth in Gross Domestic Product (GDP) and a marginally higher unemployment rate. This objective aligns with our view of a moderate reduction in the Federal Funds rate in the coming months, assuming no major disruptions in economic activity.

Next Week:

Empire Manufacturing, Retail Sales, Industrial Production, Capacity Utilization, Business Inventories, Initial/Continuing Jobless Claims, Housing Starts, Building Permits, Philadelphia Fed, S&P Global US Manufacturing/ Services Purchasing Managers Index (PMI), Leading Index (LEI), Existing Home Sales

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