Slowing shelter and weakening corporate pricing power to be the big themes in the second half of 2023
In terms of the outlook, while we don't think the Fed will need to see 2% annual inflation achieved before considering rate cuts, we do need to be consistently hitting 0.2% or 0.1% MoM. That is possible, we think, late in the third quarter into the fourth quarter given the clear topping out in housing rents, which should be increasingly reflected in the shelter CPI components as we head into the third quarter (shelter is over 40% of the core CPI basket), and weakening corporate pricing power.
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Indeed, yesterday's National Federation of Independent Business survey of price plans for US businesses recorded another sharp slowdown – a five-point decline in the proportion of companies expecting to raise prices in the coming three months, with the index back at historical long-run averages – with the index consistent with core CPI dropping to around 2.5% year-on-year by year-end. That may be a little optimistic, but if unemployment is starting to rise at the same time as 0.2% MoM core CPI prints, the Fed's dual mandate of price stability and maximum employment can justify moving interest rates lower from restrictive levels.
If, as we fear, the combination of lagged effects of 500bp of Fed rate hikes and significantly reduced credit availability, as highlighted by the Fed’s Senior Loan Officers’ survey on Monday, do slow the economy sharply and unemployment starts to rise, the momentum will increasingly swing towards rate cuts. Right now markets are pricing a 25bp cut as soon as September. That may be a little early, but we think November and December are looking decent bets for the Fed moving policy to a more neutral setting.
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