US inflation edges up in December. Will prices pressures ease in 2024?

What happened?

Inflation in the US jumped more than expected in December.

The US Consumer Price Index (CPI) rose by 3.4% in December compared to the previous year, reversing the downtrend in the previous three months.

Excluding the volatile food and energy components, core inflation maintained its declining trend. 

In December, core inflation rose by 3.9% compared to the previous year, moderating from an increase of 4% in the previous month.

With the mixed signals, this led many investors to ask if US inflation has peaked? Or will we see an acceleration in inflation once again?

Let us look at some of key indicators to understand if we inflation might ease off in 2024.

Has US inflation peaked?

#1 – Rising housing costs have pushed up inflation

A more detailed breakdown shows the main source of inflation in December was housing costs.

This housing component rose by 6.2% compared to the previous year, accounting for more than half of the rise in inflation.

Given that housing accounts for a third of the CPI basket, the outlook for the US rental market remains key to the overall inflation rate in the coming months.

This component rose sharply especially in the aftermath of the pandemic when demand for temporary housing shot up as work from home became widespread.

Fast forward to today, there are signs that new rentals have been moderating which may lower the overall CPI shelter index in the months ahead. 

#2 – Money supply growth has moderated

In our view, to know where inflation is heading a good starting point is to track the nation’s money supply.

This stems from the fact that inflation is often defined as ‘too much money chasing too few goods”.

This definition played out loud and clear during the pandemic years where global central banks flooded the world with ample money while a global lockdown led to ‘too few goods’ being supplied.

This was the period known as quantitative easing, or QE in short. 

In a nutshell, it involved central banks injecting money into the financial system to boost the economy.

Put simply, it is akin to the central bank flooding the bath-tub with water.

At its peak, the total assets of the US Federal Reserve reached a peak of USD9 trillion as they pumped huge amounts of money into the economy. 

The ECB was even more aggressive at USD10 trillion. 

However, beginning March 2022, the Federal Reserve along with its European counterparts reversed policy. 

Instead of cutting interest rates further, they started raising rates. 

Instead of flooding their economies with money, they started removing them. The result?

In November, money supply growth in the US declined by 3% compared to the previous year.  This would be significantly below its peak of a 26% expansion in Jan 2021. 

Such a dramatic decline may point to slower inflation ahead especially since global supply chains are also no longer being disrupted.

Put simply, the situation of too much money chasing too few goods which drove global inflation up is now being reversed.

#3 - Inflation expectations have come down 

During a press conference in early November, Federal Reserve Chair Jerome Powell cited that inflation expectations have remained relatively contained despite the surge in the overall inflation rate.

Powell emphasized the positive outlook for inflation expectations, stating, “It’s evident that inflation expectations are in a favourable position”. 

He added, “The public believes that inflation will gradually decrease to 2% over time, and they are correct”.

In our view, a well-behaved 5-year inflation expectations trend suggests a degree of stability and confidence among market participants. 

Tellingly, the 2 year Treasury yield has remained relatively stable despite the latest inflation figures.

#4 – Oil prices have also moderated

Oil prices have always been seen as well as a key inflation driver, and there are concerns that the Middle East situation may lead to a sudden spike in oil prices.

However, there are reasons to believe that oil prices may not see a sustained increase in 2024. 

Firstly, oil prices have remained below US$100 per barrel despite a few rounds of production cuts by OPEC+.

Next, China’s appetite for commodities has remained lacklustre as its real estate industry continues to struggle for a recovery.

Lastly, resurgent shale production in the US, the discovery of massive oil fields in Guyana and increased production from Brazil, have also led to an increase in supply. 

What would Beansprout do?

Based on the indicators shared, it appears that inflation is trending down. 

Should inflation continue to moderate, the Federal Reserve will have more room to cut rates interest rates this year. 

Some of the key data we will continue to monitor include:

• US rental prices 
• Money supply
• Consumer inflation expectations
• Oil prices

The S&P 500 gained more than 20% in 2023 on rising expectations of rate cuts. With the index now trading close to its all-time high, we will be looking out for a few technical levels to determine the near-term direction of the US market. 

According to technical analysis by City Index, the S&P 500 has been tracking the 20 Simple Moving Average (SMA) higher and is testing resistance just below the 4,800 level. 

The index would need to rise above this level to test 4,820, which was a high reached in January 2022. On the downside, the 20 SMA at 4,750 could offer some minor support.

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