QQQ - The June CPI Report: Meaningful Progress But A Long Road Ahead

2023-07-12 18:20:24 ET

Summary

• Inflation for June rose 3.1% YoY, the lowest since March 2021, and core inflation increased 4.9% YoY, the lowest since October 2021, delighting investors.
• The downward pressure on headline CPI is due to a steep decline in energy prices, the strongest deflationary pressure since 2020, and a decline in food inflation.
• Despite progress in pricing, the Federal Reserve still has a long way to go to reach its 2.8% core inflation target for 2023, suggesting more rate hikes ahead.

Earlier today, the Bureau of Labor Statistics released the June consumer price index report . Much to the delight of investors, who expected a large drop in year-over-year inflation, the report showed an even larger drop in headline inflation. Inflation for June rose 3.1% year-over-year on all items, the lowest reading since March 2021. Core inflation (which excludes food and energy) rose 4.9% year-over-year, the lowest reading since October 2021.

While challenges remain on the core side of pricing to bring stability from a Fed standpoint, the June inflation report should represent a meaningful moment in the battle to stabilize pieces.

Digging deeper into the inflation report highlights the measurable progress made in June. Not only was month-over-month headline inflation tame for three of the last four months, but core inflation also showed its lowest month-over-month reading in over a year. By taking the most recent core inflation data and annualizing it, investors can see that pricing seems to finally be heading towards coming under control.

Investors may wonder why headline CPI is now so far below core CPI, a trend that operated in reverse during 2021 and 2022. The downward pressure is being led by a steep decline in energy prices. The current deflationary pressure in energy is the strongest since April and May of 2020, and if we aren’t including the pandemic, investors would have to go back to 2015 to see energy deflation at these levels. Food inflation has also shown meaningful declines. While at 5.7% food inflation is still high, it is much better than the 10%+ it was just six short months ago.

On the core side, goods prices are leading the way towards the taming of the index. Durable goods resumed their deflationary pressure in June and their pricing has been negative in six of the last seven months. Nondurable goods saw their first deflationary month since December of 2020. While significant progress has been made on goods, other areas of pricing remain sticky.

Services, which represents a massive amount of consumption in the economy, is still experiencing inflation over 6% despite its fourth straight month of declines. Housing and rental rates also remain elevated as the country continues to deal with housing supply problems. Rental inflation has been over 8% for seven consecutive months.

While the Federal Reserve would be justified in stating that progress has been made on pricing, investors should still get a sense of the journey that remains. The Fed has core inflation pegged at 2.8% for 2023 and a long-term target of 2%. While core inflation has improved by 170 basis points since September of last year, there is still 190 basis points remaining to get to the 2023 estimate. The Fed appears to be prepared to overshoot the Phillips Curve and endure slightly higher unemployment to achieve price stability, a strategy that points to more rate hikes ahead.

Overall, investors have reason to be optimistic about the outlook for inflation. Both core and headline CPI numbers came in tame for the month of June, but future reports are going to need to be equally tame for the Fed to achieve its policy goals. Don’t be surprised to see at least another rate hike in the near future as the Fed appears focused solely on the pricing portion of its dual mandate.

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