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Weekly Update 06/14/2024: US Inflation Moderates While Fed Holds Steady

  • RTX wins a $677 million US Navy contract
  • Adobe releases earnings beating profit and revenue expectations while raising forward guidance
  • Apple announces AI strategy at World Wide Developer Conference this week
  • CACI has two significant contract wins this week – a $450 million Air Force contract and a $2 billion NASA contract

Domestic Economic News

A key measure of underlying US inflation stepped down for a second month in May, a pleasant surprise for Federal Reserve officials looking for signs that they can start to lower interest rates. The so-called core consumer price index — which excludes food and energy costs — climbed 0.2% from April, Bureau of Labor Statistics figures showed. The year-over-year measure rose 3.4%, cooling to the slowest pace in more than three years, according to data out Wednesday. The figures, taken with the deceleration in the core CPI in April, may represent the early stages of inflation resuming a downward trend. But policymakers have stressed that they’d need to see several months of price pressures receding before they consider lowering interest rates, especially with the latest jobs report reigniting the debate over how restrictive policy actually is. Stock futures and Treasuries rallied across the curve, pushing both two-year and 10-year yields down about 14 basis points. Traders fully priced in two rate cuts by the Fed this year, with the first move coming in November — two days after the presidential election. The good news is each of the four of the key measures came in one-tenth of a percent better than expected – it has been a long time since we here at SGK have been able to make that statement! So when it came out, it provided some nice relief as both stocks and bonds rallied when markets open for trading Wednesday morning.

Economists see the core gauge as a better indicator of underlying inflation than the overall CPI. That measure was flat from the prior month — the tamest in almost two years, dragged down by cheaper gasoline — and 3.3% from a year ago. The report landed just hours before the Fed was set to conclude its two-day policy meeting in Washington. “I think this was good news for the committee. They’ve been looking for a softer report, they got it here,” Jim Bullard, former president of the St. Louis Fed, said on Bloomberg Television. “We would need more news going in this direction in order to forge ahead with our easing policy. But it does keep hope alive for those that have been looking for an earlier rate cut,” he added. While the figures are reported to one decimal point by the BLS, officials have been increasingly drawing the numbers out further to get a more comprehensive picture of the direction inflation is headed. On a two-decimal basis, core CPI rose 0.16%. Policymakers also stress that a single month of data doesn’t make a trend. Core CPI over the past three months increased an annualized 3.3%, down from 4.1% in April’s calculation. Here’s what Bloomberg Economics had to say after the report: “May’s CPI report is encouraging — and the core PCE deflator will likely be even more so. We anticipate a string of similar reports this summer, setting the stage for the Fed to start cutting rates in September.” — Anna Wong, Eliza Winger and Estelle Ou.

Mortgage applications for home purchases in the US rose for the first time in five weeks as mortgage rates eased closer to 7%. The Mortgage Bankers Association’s index of mortgage applications to buy a home increased 8.6% in the week ended June 7 to 143.7, the highest level since May 3, according to data released Wednesday. The data are prone to big swings around holidays, and the latest reporting week followed Memorial Day. The group’s refinancing gauge soared 28.4%, the largest weekly advance since January 2023. The contract rate on a 30-year fixed mortgage decreased 5 basis points to 7.02%, according to Mortgage Bankers Association data released Wednesday. The rate on a 15-year mortgage slid 15 basis points to 6.6%. Mortgage rates risk staying elevated until Federal Reserve policymakers, who wrapped up a two-day meeting Wednesday afternoon, are convinced inflation is on a sustainable path toward their target. MBA’s overall index of applications, which includes those for home purchases and refinancing, jumped 15.6% last week. That was the biggest advance since early 2023. The MBA survey, which has been conducted weekly since 1990, uses responses from mortgage bankers, commercial banks and thrifts. The data cover more than 75% of all retail residential mortgage applications in the US.

Initial applications for US unemployment benefits jumped to the highest level in nine months, led by a large increase in California. Initial claims increased by 13,000 to 242,000 in the week ended June 8, according to Labor Department data released Thursday. The median forecast in a Bloomberg survey of economists called for 225,000. Continuing claims, a proxy for the number of people receiving unemployment benefits, rose to 1.82 million in the week ended June 1, which included Memorial Day. Weekly data can fluctuate around holidays.

US producer prices unexpectedly declined in May by the most in seven months, another welcome development that will strengthen the Federal Reserve’s confidence in moderating inflation. The producer price index for final demand decreased 0.2% from a month earlier, lower than all estimates in a Bloomberg survey of economists. Compared with a year ago, the PPI rose 2.2%, Bureau of Labor Statistics data showed Thursday. The PPI report follows May consumer price data that showed a broad cooling. Fed officials have since July held their benchmark interest rate at the highest level in more than two decades. Nearly 60% of the decline in the May PPI for goods was due to gasoline costs. Prices also fell for diesel fuel, commercial electric power and jet fuel. Goods prices overall decreased 0.8% — the most since October. Services costs were unchanged. Several categories in the PPI report that are used to calculate the Fed’s preferred inflation measure — the personal consumption expenditures price index — were softer in May than a month earlier. Among those, airfares fell 4.3% and prices for portfolio management services decreased 1.8%. Physician care costs were flat and the cost of hospital outpatient care rose 0.5%. The May PCE price gauge is due later this month. Stripping out food, energy and trade services, which is an even-less-volatile PPI measure, prices were flat compared with the prior month, the tamest in a year. Costs of processed goods for intermediate demand, which reflect prices earlier in the production pipeline, decreased 1.5% — the most since the end of 2022. That reflected plunging energy costs.

US consumer sentiment unexpectedly fell to a seven-month low in early June as high prices continued to take a toll on views of personal finances. The sentiment index dropped to 65.6 in June from 69.1, according to the preliminary reading from the University of Michigan. The median estimate in a Bloomberg survey of economists called for the measure to rise to 72. Consumers expect prices will climb at an annual rate of 3.1% over the next five to 10 years, up slightly from the 3% expected in May, the data out Friday showed. They see costs rising 3.3% over the next year, the same as in the previous month. A gauge of consumers' current assessments of their personal finances slid 12 points to 79, the lowest since October and also reflecting concerns about incomes. Views about economic conditions dropped to the weakest since end of 2022. The decline in sentiment coincides with signs that the labor market, which has driven consumer spending over the last year, is softening. The unemployment rate rose to 4% last month, the highest in more than two years, government data showed. “While lower-income families have, as a group, seen notable wage gains in a strong labor market, their budgets remain tight amid continued high prices even as inflation has slowed,” Joanne Hsu, director of the survey, said in a statement. “The views of middle-income consumers resemble those of their lower-income counterparts, a departure from historical patterns in which their mentions are squarely in between those of higher- and lower-income consumers.” The slide in sentiment suggests restrained consumer demand in coming months. The university's measure of buying conditions for durable goods decreased to the lowest level since December 2022. A measure of consumer expectations also fell, to the lowest this year.

Interest Rate Insight and the Fed

Federal Reserve officials penciled in just one interest-rate cut this year and forecast more cuts for 2025, reinforcing policymakers’ calls to keep borrowing costs high for longer to suppress inflation. Officials voted unanimously to keep the benchmark federal funds rate in a range of 5.25% to 5.5% — a two-decade high first reached in July. But policymakers signaled they now expect to cut rates only once this year, compared to the three reductions forecast in March, according to the median projection. They now see four cuts in 2025, more than the three previously outlined. “The most recent inflation readings have been more favorable than earlier in the year, however, and there has been modest further progress toward our inflation objective,” Chair Jerome Powell said Wednesday following the conclusion of a two-day meeting in Washington. “We’ll need to see more good data to bolster our confidence that inflation is moving sustainably toward 2%.” Individual officials’ views on the best path forward for borrowing costs differed. The Fed’s “dot plot” showed four policymakers saw no cuts this year, while seven anticipated just one reduction and eight expected two cuts. The Federal Open Market Committee adjusted language in its post-meeting statement, noting there has been “modest further progress toward the committee’s 2% inflation objective” in recent months. Previously, the statement pointed to a “lack” of further progress. Fed officials have repeatedly said interest rates are likely to stay elevated for longer after price pressures picked up in the first quarter. But the change nods to more current data showing that price growth ebbed in April and May. As we noted the CPI data released earlier Wednesday offered some reassurance that progress toward the Fed’s 2% inflation target has resumed.

Powell said the officials welcomed the latest figures, adding that he hopes for more reports like that. He said Wednesday’s figures had helped build their confidence on the trajectory of inflation but not enough to warrant rate cuts at this time. “Rate cuts that might have taken place this year take place next year,” he said. “There are fewer rate cuts in the median this year, but there’s one more next year.” Other countries have already begun to lower borrowing costs. The European Central Bank cut interest rates last week, as did the Bank of Canada. Yields pared their day’s decline as Powell spoke to reporters. Traders are still betting the Fed will most likely cut rates twice by year end, and see better-than-even odds of a first cut in September. Fed officials also published fresh forecasts for inflation, raising their projection for underlying inflation to 2.8% from 2.6% in March. They maintained their forecasts for economic growth and the unemployment rate at 2.1% and 4% respectively. The unemployment rate climbed to 4% in May. Powell described the overall labor market as strong but gradually cooling, comparing it to the state of the jobs market at the cusp of the pandemic. However, he acknowledged that an unexpected weakening could warrant a response by the Fed.

Officials also raised their projections for where interest rates will settle in the longer term, to 2.8% from 2.6% at the March gathering. The increase, following a slight bump in March, hints policymakers expect higher interest rates are here to stay. Some officials, including Dallas Fed President Lorie Logan, have said higher borrowing costs may not be slowing the economy as much as previously thought. Still others, such as New York Fed President John Williams, have said that policy is well positioned to bring inflation down to the Fed’s goal. US central bankers are engaging in a broader discussion about whether the neutral rate, or the rate at which the Fed is neither slowing nor stimulating the economy, has risen since before the pandemic. A higher neutral rate would suggest that monetary policy is not doing as much to restrain the economy. “The question of whether it’s sufficiently restrictive is going to be one we know over time,” Powell said. “The evidence is pretty clear that policy is restrictive and is having the effects that we would hope for.” While US economic growth is moderating and spending is cooling, some aspects of the economy are proving more resilient to higher borrowing costs. US nonfarm payrolls surged by 272,000 in May, surpassing all projections in a Bloomberg survey of economists, and average hourly earnings growth picked up. The unemployment rate — which is derived from a separate survey — increased to 4% from 3.9%, rising to that level for the first time in over two years. The Fed also said it would continue to shrink its balance sheet at the slower pace announced in May. Starting this month, the central bank will let its holdings of Treasury securities fall by up to $25 billion a month, down from the previous cap of $60 billion. The cap for mortgage-backed securities was left unchanged at $35 billion.

Overall there were no major surprises and traders seemed to take it in stride.

Impactful International News

European stocks headed for their worst week since October on growing concerns about political turmoil in France. The Stoxx 600 weakened 0.3% to extend losses since Monday to 1.7%. France’s CAC 40 index slumped 1.4%, weighed down by banking shares such as BNP Paribas SA and Societe Generale SA. The euro fell to its lowest against the dollar since April in Friday trading. A gauge of the dollar rose against major global currencies, while Treasury yields declined two basis points. European markets are increasingly anxious after French President Emmanuel Macron announced a snap legislative election following his party’s drubbing in the European Parliament elections. Investors fear a win for Marine Le Pen’s far-right National Rally party, which leads polls by a wide margin, will usher in looser fiscal policies. The uncertainty has sent the premium France pays on its debt relative to Germany soaring this week, on pace for the biggest move stretching back to the European debt crisis in 2011. “It’s hard to ignore the parallels between our current situation and the time of the sovereign debt crisis, as there’s that familiar focus on election results, sovereign bond spreads and debt sustainability,” said Jim Reid, an analyst at Deutsche Bank AG. That’s “coupled with no obvious sign about where things are headed next.” In Asia, MSCI’s Asia Pacific index slipped as losses in Australian and Chinese stocks offset gains in Japan’s benchmark. The Bank of Japan triggered a slump in the yen after making investors wait until its July meeting for details on its paring of bond buying, a move that was also seen as a delay in the normalization in policy. Still, Governor Kazuo Ueda said he sees the possibility of a rate hike in July, depending on data. A “weak yen might weight down the flows from overseas investors in the summer,” said Hiromi Ishihara, head of equity investment at Amundi Japan. “That said, we still believe that BOJ is set to move a further hike this year.”

Euro-zone industrial production unexpectedly fell at the start of the second quarter, casting a shadow over the economy’s pickup this year from its poor performance in 2023. Output fell 0.1% in April from the previous month, which was revised lower to a 0.5% gain, Eurostat said in Luxembourg on Thursday. Economists expected a 0.2% increase, according to the median of 29 estimates. The outcome leaves the euro-zone economy leaning more heavily on services to continue its recovery after a growth spurt in the first quarter. The European Commission forecasts expansion of 0.8% in 2024, double the pace of last year. While an interest-rate cut by the European Central Bank last week may offer future aid to the economy, policymakers are shirking from further moves for now as they gauge the strength of inflation. They said last week that manufacturing is showing signs of “stabilization at low levels” after a year when the energy crisis in the wake of Russia’s invasion of Ukraine crippled production in Germany, the region’s biggest economy, with knock-on effects to its partners. The report on Thursday did show some bright spots. Aside from a decline in intermediate goods, all other categories improved, including a 0.7% increase for capital goods, marking its third month of gains. Geographically meanwhile, poor results were mainly seen in the region’s smaller countries, with the biggest drops in Luxembourg, Latvia, and Ireland. Of the euro zone’s largest four economies, only Italy suffered a decline.

The German finance ministry is considering a supplementary budget for this year with additional borrowing of as much as €11 billion ($11.9 billion), according to people familiar with the discussions. Negotiations within the ruling coalition are ongoing and a final decision on a revised 2024 finance plan — which could include a spending freeze — has not been taken, said the people, who asked not to be identified as the talks are confidential. Finance Minister, Christian Lindner, could potentially take on more federal debt without breaching the borrowing rules in Germany’s constitution as they provide some wiggle room in times of economic weakness. Net new debt was projected to be around €40 billion this year, down from about €70 billion in 2023, while Europe’s biggest economy is expected to stagnate after shrinking in 2023. A spokesperson for the finance ministry said the government is monitoring the development of tax revenue and is ready to act at any time if needed. The possibility of a supplementary budget was first reported by Bild newspaper. Chancellor Olaf Scholz’s unwieldy three-way coalition is currently locked in difficult negotiations on next year’s budget, which it hopes to sign off in cabinet on July 3.

Company Events

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