At their September 18th meeting, the FOMC cut its Federal Funds Target Rate by 50 basis points. Looking ahead, the Fed Funds futures market expects an additional 200 basis points of rate cuts by the end of 2025. Our view has been that those expectations are aggressive, especially in the near term, given the inflation setup. With the 10-year U.S. Treasury yield already 100 basis points lower than its 2024 high, we would expect to see some reversal of that move if the Fed does not cut as fast or as much as the Fed Funds futures market is currently expecting. Over the next few months we will be monitoring Shelter inflation, the price of oil, and other commodities, alongside key market signals like the 5-year breakeven inflation rate to help determine whether the current expectations are more or less likely to come fruition.
Source: Bloomberg.
Source: Koyfin.
In the August CPI release, we saw the first indication of stalling in Shelter’s contribution. It had been contributing positively by a lesser amount each month since April 2023, but in August it contributed 1.85 percentage points, up from a 1.79 percentage point contribution in June. On a y/y basis, Shelter accelerated to 5.21% from 5.03% and has been above the 2015 to 2019 average of 3.30% since October 2021. The Housing component in the PCE Price Index has followed a similar path, coming in at 5.27% for July and above its 2015 to 2019 average of 3.30% since November 2021. We had been waiting to see if an inflection would occur in these price measures as more real-time home/rent prices made their way into the calculations on a lag. Over the next few months this will be an important indicator to watch.
Source: Macrobond.
If inflation was going to accelerate in the fourth quarter and into 2025, we would expect to see oil and other commodity prices pick back up. While the price of WTI Crude Oil moved lower in September, the end-of-month average must wind up around $60 per barrel over the next three months to remain as disinflationary as it had been. Looking at the math, the end-of-month average for September is currently at $68.8, -23% from last September’s $89.4. Last October’s end-of-month average slowed to $85.5, thus if Oil does not decline by roughly 6% to $65.0 this October, then the rate of change on a y/y basis will accelerate. Using the same calculation moving out to December, the setup becomes less disinflationary (less negative in y/y terms) as the comparison set rolls down to $77.4 in November and $72.1 in December.
Source: Koyfin.
Source: Macrobond.
Outside of oil, most metals (industrial and precious) and agricultural commodities have also increased over the last week. Additionally, one of the commonly used market-based inflation signals, the 5-year breakeven inflation rate, has risen from a multi-year low made on September 10th.
Source: Bloomberg.
Ultimately, we believe long-end rates reflect the outlook for future growth and inflation and would likely stop declining if the data relayed above continues its current path. We will continue to monitor incoming macro and market data for a gauge on the most probable path for interest rates.
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