Flash Macro: U.S. Inflation

U.S. Core CPI inflation came in at 0.1% m/m in June, 10 basis points below consensus and the lowest level since 2021. Core inflation has now fallen for the last five months, driven by a slowdown in Housing inflation (which we have been expecting) and Supercore inflation (which was more abrupt than we or markets had anticipated). Overall inflation was -0.1% month-over-month and 3.0% year-over-year, compared to a consensus of 3.1%.

Reflecting these shifts, our 2024 CPI inflation forecast falls to 3.0% from 3.2% previously. Meanwhile, we make no change to our 2025 CPI estimate of 2.5%, which already reflected the moderation in Supercore now playing out a bit faster than expected.

Looking ahead, the ‘needle-mover’ for the Fed is now growth, not inflation. For the last two years, the Fed has been focused on managing upside inflation risks, especially around Services. As such, we now think Chair Powell will be more focused on managing downside growth risks. Although our base case remains that the U.S. will avoid a hard landing, we see noisy growth data (including a bifurcation between temporary help employment, which has been very weak, and capex/construction, which has remained strong) will bias the Fed toward a sooner start to rate cuts, likely in September.

We now think growth and long end yields – not inflation and short rates – will drive the cycle for risk assets. We continue to see scope for Treasury yields to move still lower towards 4% over the next year, which implies ~5.5-6.0% total return potential. Meanwhile, we expect average cash yields of just ~5% over the next year, versus 5.375% over the last twelve months. Our bottom line is that the driver of returns is shifting from carry to convexity as the Fed becomes more focused on managing downside risks to growth.

The key pieces of our narrative for a capital markets recovery are coming into play, including a global easing cycle and mounting signs for a weaker dollar. However, broader participation will require a clearer signal on growth, which we view as a prerequisite for market breadth to widen out beyond mega-cap AI. As we detail below, we see this happening heading into 2025.