CPI June Reaction: Don’t Be Fooled by the 0.4% Month-Over-Month Gain in the Core!

Following the June 13 CPI report that shows inflation has dipped to 4% year-over-year (YoY) but Core inflation is up 0.4% on the month, Leland Abrams of Wynkoop, LLC and a portfolio manager of a fixed income fund at Catalyst, provides his initial reaction below:

Today’s headline CPI came in as expected with a +0.1% month-over-month change and the YoY came down to 4%, slightly lower than expectations.  We expect next month’s YoY to come down even further to a 3% handle.  Core CPI registered at +0.4%, inline with market expectations, while the YoY ticked down to 5.3%.

Importantly today, the super core (ex-food, energy, and housing), came in at only +0.23%, showing good progress.  The largest segment of the core (housing) continues to show monthly gains (+.5% this month) but it is highly lagged and will likely drive disinflation through the rest of the year as the data finally begin to reflect what has actually happened (housing and rents are down YoY).

Interestingly, a significant contributor to core CPI this month was used car prices, showing a +4.4% monthly gain, which added approximately 12 bps to the core reading.  If we look at super core ex-used cars, the number was only a +0.11% monthly change, which is within the Fed’s target.  The last two months have shown gains in used car prices at the retail level, which is likely trickling through from February and March’s higher wholesale prices.  However, Manheim auction data showed a -2.7% price drop in May and -3.1% in April.  We expect this to show up the next two months as a negative number for used cars, which could push the super core closer to 0% MoM during this period.

The Initial Market Response:

The bond market initially rallied but then gave up gains and now yields are higher on the day.  We suspect shorts are continuing to hit the market as the 30-year auction lingers later today as well as the FOMC rate decision on deck for tomorrow.  The market expects the Fed to pause/skip a rate hike tomorrow, but to show higher potential rates on their summary of economic projections dot plot.  Based on our analysis of the data, reading between the lines, we believe the market is overpricing the chance for a July hike and think the Fed should be and could be done.  Time will tell…