U.S. August PPI Review: Inflation Pressure Eases, Rate Cut Expectations Surge

On September 12th, the U.S. Department of Labor released the Producer Price Index (PPI) data for August. The data shows that the PPI increased by 1.7% year-over-year in August, slightly below expectations, and rose by 0.2% month-over-month, slightly above expectations. Overall, the U.S. PPI growth was relatively modest, indicating that cost pressures are continuing to ease and inflationary pressures are subsiding.

After the release of the PPI data, market expectations for a rate cut strengthened, with the yield on the U.S. 10-year Treasury continuing to decline. According to CME data, the probability of a 50 basis point rate cut in September quickly rose from 14% to 43%, while the probability of a 25 basis point rate cut fell from 86% to 57%.

The U.S. Department of Labor (BLS) released the August PPI data, with the key points as follows:

1. The PPI increased by 1.7% year-over-year in August, below market expectations, marking the lowest year-over-year growth rate since February. The month-over-month PPI growth rate for August was 0.2%, above the market expectation of 0.1%. Breaking it down, the PPI rise was mainly driven by a 0.4% increase in service prices, with lodging costs surging by 4.8%, significantly contributing to the rise in service prices. Commodity prices remained flat in August, primarily due to a 0.9% drop in energy costs, which limited the rise in commodity prices.

2. Excluding food, energy, and trade services, the core PPI increased by 2.4% year-over-year in August, slightly higher than July's 2.3% and in line with market expectations. The month-over-month core PPI growth rate was 0.3%, above the market expectation of 0.2%.

3. The Department of Labor revised down the July PPI data, lowering the year-over-year growth rate for July from 2.2% to 2.1%.

U.S. macroeconomic data releases have been dense, and we can observe that all economic indicators are becoming clearer and more consistent.

The data shows that the overall CPI growth rate slowed more than expected to 2.5% year-over-year in August, while the core CPI, excluding the more volatile food and energy prices, remained stable at 3.2% year-over-year, primarily due to rising housing costs and a tight rental market. If we exclude food, energy, and housing prices, we find that this "super-core inflation indicator" has stabilized in recent months and even showed a slight positive move in August, indicating strong demand for services.

Combining the latest August CPI and PPI data, we can conclude that overall U.S. inflation has indeed eased, but underlying inflation remains somewhat sticky. Overall, the pace of inflation slowdown in the U.S. is relatively slow, reflecting a slowing but resilient U.S. economy.

The data shows that initial jobless claims for the week ending September 7th were 230,000, against an expectation of 227,000, with the previous value also at 227,000. Meanwhile, the non-farm payroll data for August showed an increase of 142,000 jobs, below the expected 165,000, with a significant downward revision to the previous value. The unemployment rate dropped from 4.3% in July to 4.2% in August. Labor market data indicates that labor demand in the U.S. is slowing, but the unemployment rate has not continued to rise, and wages have picked up month-over-month, similarly reflecting a slowing but not recessionary U.S. economy.

Given the recent inflation and labor market data releases, expectations for a rate cut have continued to strengthen. A rate cut by the Federal Reserve in September is almost certain, with the current debate focusing on the magnitude of the September rate cut and the total rate cuts for the year.

According to CME data from September 13th, the probability of a 25 basis points rate cut in September stands at 57%, still the majority view, while the probability of a 50 basis points rate cut has surged from 14% to 43%, reflecting increased market expectations for a rate cut. By the end of 2024, the probability of a cumulative 125 basis points rate cut has risen from 31% to 41.3%, becoming the most likely scenario, while the probability of a cumulative 100 basis points rate cut has decreased from 46.4% to 34.2%. The Federal Reserve will hold three more FOMC meetings in 2024, in September, November, and December. Assuming a 125 basis points rate cut, two of these meetings would need to announce a 50 basis points rate cut.

Chart: Probabilities of Target Interest Rates for the December 18, 2024, FOMC Meeting

Source: CME

We believe that although the U.S. economy is slowing, it remains resilient overall, and the market's bet on a 125 basis points rate cut this year may be overly aggressive. Additionally, if the Federal Reserve cuts rates by 50 basis points in September, it could trigger market fears of an economic recession. Given the relative stability of the U.S. economy and the stickiness of core inflation, the Federal Reserve lacks sufficient motivation to cut rates by 50 basis points.