Inflation Coming into Balance

By Presidio Wealth Partners on June 21, 2024

May Inflation and Fed Decision

May’s Consumer Price Index (CPI) came in cooler than expected with headline CPI rising 3.3% y/y and core CPI rising 3.4% y/y. Core CPI showed its softest increase since August 2021, a good sign that inflation is slowing to the Fed’s target. Falling gas prices were a large reason behind the dovish print, declining -3.6% in the month.

One of the largest components of CPI, shelter, is still running hot with prices up 5.4% y/y. But with that, May was the first month since October 2023 that both headline and core CPI came in lower than expected. Following the data release, the probability for a 25 bp rate cut in September rose to 73% from 53% a day prior.

Chart 1: May CPI Was Flat M/M For the First Time Since July 2022[1]

The Federal Reserve released its updated policy statement a few hours following May’s CPI release, leaving the federal funds rate unchanged at 5.25%–5.50%, as markets expected. Notably dovish, the committee altered its wording to now seeing, “modest further” progress on inflation from its previous statement of a “lack of further progress.” Powell noted that the labor market is in better balance and that the economy has made considerable progress toward its goals. With that said, more positive data is still needed for the Fed to increase its confidence that inflation is moving sustainably to 2%.

The Fed also released its updated Summary of Economic Projections (SEP), showing that members see one 25 bp cut this year, down from the previous estimate of three. They project the long-term federal funds rate to be 2.8%, while increasing the year-end personal consumption expenditure (PCE) inflation rate to 2.6% and left GDP growth expectations unchanged.

We do not think the Fed needs to cut rates this year as economic growth and consumption remain strong — a main reason behind elevated inflation. Atlanta Fed GDPNow is projecting 3% annualized growth in the second quarter, above long-term trends. Last week’s initial claims number was 242K — well below the five-year average of 494k and ten-year average of 373k. Jobs gains are growing at an above-average rate and credit spreads are near all-time tights, all signs of a strong economy.

The Consumer Is Holding Up

Last week at a Morgan Stanley conference, Bank of America stated the “Consumer is still very healthy, they still have balances leftover,” with 23% more funds in their checking accounts than pre-pandemic.[2] Credit card payments are also reverting to pre-pandemic trends with loss rates near 2019 levels. Consumer spending is still strong with Bank of America customers spending 3.5% more than last year, down from 5% in the previous year. Lower-end clients have shown higher demand for borrowing relative to middle and upper-end. As consumption accounts for 70% of GDP, high consumer spending and activity will help lead to solid overall economic growth. We believe fiscal stimulus is still aiding the economy and consumers, leading to better growth and stickier inflation.

Broadening AI Growth

Broadcom (AVGO) reported stellar Q2 2024 earnings last week, growing net revenues 42% y/y with management stating that its results were once again, “driven by AI demand and VMware.” The company raised its full-year sales guidance and announced a 10:1 stock split.

AVGO boasts gross margins up 76.22%, which grew by 56 bps y/y. Its acquisition of VMware last year has proven to be a success with its revenues contributing to AVGO’s sales growth and full-year forecast. Importantly, the company’s AI revenue was up 280% y/y. CEO Hock Tan stated on the earnings call that its hyperscaler customers (GOOGL, META and Bytdance) are “accelerating their investments,” with AVGO being a beneficiary.[3]

Chart 2: Broadcom is Up 37% in June Alone Following Q2 Earnings Beat[4]

Fixed Income

U.S. Treasuries rallied throughout the week following soft prints in May’s CPI and PPI numbers; U.S. 2, 10, & 30- year yields fell by 11, 19, & 19 bps, respectively. Dampening the rally, Chair Powell leaned hawkish in FOMC comments, and the Fed revealed a new dot-plot which saw upwards revisions to the longer-run policy rate forecasts. Eight Fed chairs saw 50 bps of cuts, seven saw 25 bps, and four saw no cuts at all. Market participants are now pricing in a 76% chance of a cut in September’s meeting, with two total cuts priced in for the year. High yield spreads widened by 20 bps to +370 bps. Muni yields followed treasuries, with yields down 11–12 bps across the curve.

The Week Ahead

Earnings – Thursday: ACN, SWBI, KR; Friday: KMX, FDS.

Economics – Tuesday: Retail Sales, Industrial Production, Manufacturing Production, Business Inventories; Thursday:  Building Permits, Housing Completions, Housing Starts; Friday: PMI Manufacturing, PMI Services, Existing Home Sales.

Return for Selected Indices^[5]

[1] Source: FactSet. As of June 14, 2024.

[2] Source: Bloomberg. As of June 11, 2024.

[3] Source: CNBC. As of June 12, 2024.

[4] Source: FactSet. As of June 17, 2024.

[5] Source: Bloomberg. As of June 17, 2024.