During the December FOMC meeting, the committee updated its projections for monetary policy which suggested three rate cuts were a possibility in 2024. At that time, the market’s expectations for rate cuts indicated six to seven rate cuts were a possibility this year with the first rate cut most likely occurring in March. Over the course of the first quarter, the market’s expectations for the amount and timing of rate cuts have shifted to be more in line with the initial FOMC projections.
Our focus since the end of last year has been on tracking the incoming data through the lens of whether the data would move in a direction and at a pace that would justify rate cuts from the Fed’s point of view. In particular, would inflation get to the Fed’s 2.0% target rate of inflation in the timeframe that the market was expecting the Fed to be cutting its policy rate?
Using simple m/m growth rate assumptions, applying those m/m growth rates to the index level, and transforming that adjusted index to plot out the y/y growth rates twelve months forward, we see that the path to 2.0% headline CPI remains difficult. If headline CPI accelerated at 0.2% m/m on average over the next year, the y/y growth rate would not hit 2.0%. To get to 2.0% y/y by August, the m/m growth rate would have to come in at 0% or lower on average over the next six months. Historically, it is rare for CPI to average 0% or lower on a rolling six-month basis. In 650 observations going back to 1970, thirty-four months registered at or below that rolling six-month mark.
To add a layer of historical context, we can look at the periods within which those m/m growth rates occurred.
- June through August 1986 (3 months)
- Oil declined 40-60% on a y/y basis
- Not a recession
- November and December 2001 (2 months)
- Oil declined 20-50% on a y/y basis
- Recession
- November 2008 through May 2009 (7 months)
- Oil declined by 25-65% on a y/y basis
- Recession
- May 2010 through July 2010 (3 months)
- Oil decelerated from +80% y/y to +8% y/y
- Not a recession
- April 2013 (1 month)
- Oil declined by 5-15% on a y/y basis
- Not a recession
- November 2014 through April 2015 (6 months)
- Oil declined by 20-60% on a y/y basis
- Not a recession
- January and February 2016 (2 months)
- Oil declined by 25-50% on a y/y basis
- Not a recession
- April 2020 through July 2020 (4 months)
- Oil declined by 25-150% on a y/y basis
- Recession
Aside from the frequency of deflationary environments, the current setup has its own variables worth highlighting. First, the shelter component has been the primary driver of y/y headline CPI growth going back to March 2023. As of February, shelter CPI has slowed to 5.7% y/y, accounting for 2 percentage points of the 3.2% headline number, or 63% of total inflation growth. Given the lagged nature of the shelter data, we can assume this will likely continue to decelerate on a rate of change basis over the next two quarters. However, to bring its headline contribution to 1.0 percentage point by August, the y/y growth rate would have to slow to 2.9%, implying 0% m/m growth on average through August. Decelerations of that magnitude occurred in December 1982 through April 1983, July 2009, and September 2009 through June 2010 (3% of the 650 observations going back to 1970). While the y/y base effects will start to ease in coming months, a halving of shelter’s y/y growth rate by August remains difficult.
Everything other than shelter, the All Items less Shelter series, has been mostly reaccelerating since June 2023, reaching 1.8% y/y in February, accounting for 1.2 percentage points of headline growth. If the m/m growth rate averages 0% or lower through August, the y/y growth rate will be 0.9% and contribute 0.6 percentage points to headline CPI. Similar, to the headline and shelter data, moving at m/m growth rates of this nature tend to be rare. More importantly for this series, the easing y/y comparison set through June could lead to a rate of change acceleration, even if m/m growth is 0.1% or 0.2% (the rolling six-month m/m growth rate has been between 0.13% and 0.22% since August). This setup likely makes it more difficult to get y/y headline CPI growth to 2.0% in the market’s current timeframe.
Underneath the All Items less Shelter series, we are focused on the rates of change in gasoline prices. From July 2022 through June 2023, the deceleration in gas prices had been helpful in terms of bringing headline CPI lower (the amount it was adding to y/y CPI growth was declining). Over the last seven months, however, that dynamic has shifted and the amount it is subtracting from headline CPI growth is declining (less negative on a y/y basis). This setup has caused some of the m/m volatility that we have highlighted in prior posts and could start to add percentage points to y/y headline CPI in the middle part of 2024. Again, this adds to the difficulty in reaching that 2.0% Fed inflation target.
The point of walking through this data is to highlight the difficulty of getting to 2.0% inflation in the timeframe that the Fed had guided towards, and the market had been expecting. Additionally, it is important to note the types of economic environments that flat to negative m/m inflation growth tend to occur in. These deflationary periods typically coincide with meaningful rate of change decelerations in oil prices and/or outright recessions. For the current environment, the takeaway is that we would have to see a meaningful decline in demand to reach 2.0% y/y CPI growth in the timeframe that the market expects the Fed to be cutting its policy rate.
The views expressed herein are presented for informational purposes only and are not intended as a recommendation to invest in any particular asset class or security or as a promise of future performance. The information, opinions, and views contained herein are current only as of the date hereof and are subject to change at any time without prior notice.
Investment Strategist
Boyd Watterson Asset Management, LLC