U.S. inflation falls to lowest level in three years

Executive summary:

U.S. consumer-price gains eased to 2.9% in July–the lowest increase since 2021
We believe markets may be too aggressive in their projections for Fed rate cuts this year
UK unemployment fell unexpectedly in June

On the newest episode of Market Week in Review, Director of Investment Strategies, Shailesh Kshatriya, and Senior Internal Communications Analyst McKenna Painter discussed the latest batch of U.S. macroeconomic data. They also chatted about the outlook for U.S. Federal Reserve (Fed) rate cuts as well as recent inflation and labour market numbers from the UK.

U.S. markets rebound on encouraging economic data

Painter and Kshatriya began by unpacking the latest economic data from the U.S., which Kshatriya characterised as encouraging, especially in the wake of the global market rout on 5 Aug. He said that recently released data pertaining to inflation, jobs, and retail sales has helped financial markets recover from the early August selloff, which was fuelled by a disappointing U.S. employment report and the unwinding of the popular Japanese Yen carry trade. In fact, as of market close on 15 Aug, the benchmark S&P 500® Index was back to the level it stood at when the month began, Kshatriya pointed out.

The key report released the week of 12 Aug was July’s U.S. consumer price index (CPI), he said, noting that headline inflation tracked largely in line with consensus expectations, rising at a 2.9% annual rate. “This was the first time since March 2021 that the headline CPI came in below 3%,” Kshatriya remarked, adding that core inflation eased to 3.2% on a year-over-year basis as well.

Moreover, the U.S. producer price index (PPI) also moderated during July, Kshatriya said, rising by only 2.2% on an annual basis–compared to June’s 2.7% increase. This is important, he explained, because producer prices ultimately feed into consumer prices and also inform the U.S. Federal Reserve’s (Fed) preferred inflation gauge, the personal consumption expenditures (PCE) price index.

Kshatriya noted that the good news wasn’t just limited to U.S. inflation, with positive trends also observed in consumer spending and the labour market. He explained that U.S. retail sales during July were stronger than expected, while weekly initial jobless claims moderated from the previous week, coming in below consensus forecasts. “The decline in U.S. unemployment claims indicates that the labour market is slowing, but in a measured way,” he remarked, stressing that overall, the latest economic data has generally been pretty supportive ever since the early August selloff.

How many Fed rate cuts could be in store through year-end?

Shifting to U.S. monetary policy, Kshatriya noted that the rollercoaster ride in markets this month has also led to whipsawing market expectations for Fed rate cuts. He explained that a few months ago, investors were anticipating just one rate cut for 2024. After markets plunged on 5 Aug over growth fears, expectations swung wildly to five rate cuts for the rest of the year–an amount the strategist team at Russell Investments felt was probably too aggressive, he noted.

“Our view on rate cuts has been a little more steady throughout the year. We did recently raise our rate-cut projection from two to three, and markets are gradually shifting toward our view,” Kshatriya said, noting that markets are currently pricing in roughly four rate cuts this year.

The strategist team’s baseline outlook calls for an initial 25-basis-point (bps) rate cut in September, followed by 25-bps cuts at the Fed’s final two meetings of the year in early November and mid-December, he stated. Kshatriya added that a 50-bps cut at one of the meetings is possible, but said that in order for that to happen, there will likely need to be more evidence that the U.S. labour market is weakening.

Conflicting labour-market data in the UK

Painter and Kshatriya wrapped up with a look at the latest inflation and jobs numbers from the UK. Starting with inflation, Kshatriya said that headline inflation ticked up to 2.2% in July from 2% in June, while core prices rose at a 3.3% clip–down slightly from June’s 3.5% gain. “Importantly, both of these numbers were below expectations,” he remarked.

Pivoting to labour-market data, Kshatriya said that the latest numbers were somewhat conflicting. On the one hand, the UK employment report for June came in stronger than anticipated, with the economy adding more jobs than anticipated and the jobless rate falling from 4.4% to 4.2%, he said. On the other hand, the UK saw a significant increase in the number of individuals filing for unemployment benefits during the month of July, which suggests there could be a potential cooling in the country’s labour market down the line, Kshatriya remarked.

So, how might the latest numbers impact future decisions by the Bank of England (BoE) on rates? Kshatriya noted that markets currently anticipate the UK central bank, which cut rates for the first time this cycle on 1 Aug, to forego a cut at its next meeting in September. Thereafter, expectations are for two rate cuts in the remainder of the year, he said. “At Russell Investments, this is roughly in line with where we see the base rate standing at the end of 2024,” Kshatriya concluded.

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Any opinion expressed is that of Russell Investments, is not a statement of fact, is subject to change and does not constitute investment advice.