CPI clears the way for cuts #NewsMarket

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CPI

It is a sign of how much progress we have made in quelling inflation that one can nitpick good inflation reports without feeling ungrateful. And yesterday’s CPI report, good as it was, could have been a teensy bit better. Unhedged likes looking at CPI in terms of the month-to-month change annualised, excluding food and energy. Measured that way July was right in line with May, but warmer than June:

All three readings were above the magic 2 per cent level, but still, we like it when the line goes down. Perhaps that is why the market was flattish on Wednesday. If the reading had been a straight repeat of June, the odds of a jumbo (50 basis point) interest rate cut in September may have risen. As it was, the odds fell a touch.

Note that the biggest reason for the warmer July was an uptick in shelter inflation, a category that has consistently frustrated forecasters. But if one keeps the faith that timely private housing data must lead the lagging CPI housing measure, one can conclude that July was a blip. Meanwhile, non-shelter services, a category the Federal Reserve is particularly attuned to, continues to cool.

The exact number of cuts this year is not worth obsessing over for anyone except rate traders. The important point is that three months of benign inflation reports definitively clears the way for easier policy. The key question now is how those cuts will be presented by the Fed and understood by the market. Will the cuts be justified purely by abating inflation pressures — or by fears of recession, as well? Risk assets like the first kind of cut, not the second. Inflation is fine. Watch the job market.

This item has been amended to clarify a reference to the US inflation target.

Some things earnings season taught us about the US consumer

Walmart reports second-quarter results this morning, one of the last giant US companies to do so. To put some context about what we hear from the country’s biggest retailer, we combed through the earnings reports of large US consumer companies. Some interesting themes jumped out:

In food, demand varies a lot depending on position in the price/quality spectrum. In restaurants, the crucial distinction may be between brands people trade down toversus brands they trade down from. That does not mean that the cheapest product wins. Chipotle (thriving) is pricier than McDonald’s (wobbling), but it appears to be a down-to trade for richer consumers.

The snack maker Mondelez emphasised that in grocery stores, the price simply has to be right:

And probably the most important thing we’re seeing about the consumer is that the definition of value has changed for many people, because if you look two, three years back . . . people were drifting more towards family and party-size pack, and that benefited us. Now, particularly lower-income consumers, they have moved to a basket size that they can afford. And if the biscuit brand that they like can fit in there at the right price point they will buy. If not, they will not buy any biscuits.

Pepsi echoed the sentiment:

In the US, there is clearly a consumer that is more challenged and is a consumer that is telling us that in particular parts of our portfolio, they want more value to stay with our brands.

Travel and leisure is doing well — but consumers are a bit more cautious. One way to see this is in booking windows. For the two years after the pandemic, travellers were booking vacations very far in advance — excited to get out of the house and keen to lock in rates before prices rose further. But according to Booking.com and Airbnb, consumers are now booking trips with a much shorter lead time.

The US consumer is definitely still taking holidays, though. From Booking.com:

So both in terms of the star ratings as well as in the length of stay, it’s relatively stable to what we have seen in previous periods, maybe with one exception. There is a really mild indication of some trade-down in the US.

Meanwhile, cruise lines such as Royal Caribbean and Norwegian Cruise had banner quarters, and expect to maintain pricing power.

Big consumer brands are doing welland are not seeing much trading down to store brands. Asked about reports of a weakening consumer in recent months, the CEO of Procter & Gamble said:

We generally don’t see the dynamic that some are describing . . . if you look at a couple of dynamics, private label shares as an example, which typically would be increasing during a time of significant consumer pressure, that’s not what we’re seeing . . . Is unit growth declining? That’s not what we’re generally seeing.

Colgate did cut some North American prices during the quarter, but volumes responded. Here’s the CEO:

On the volume side we saw great improvement. And that, what was particularly encouraging there is we saw household penetration as a result of that . . . Market share is more or less flat in value but up quite considerably on the volume side.

Kenvue, maker of products such as Band-Aid and Tylenol, noted that “consumers are willing to pay a premium for brands that are science-backed”.

Big home projects are being delayed. Home Depot noted that the many home improvement projects are debt financed and that rates are pinching. HD CEO:

Higher interest rates and greater macroeconomic [pressures] . . . result[ed] in weaker spend across home improvement projects . . . we believe a more cautious sales outlook is warranted for the year . . . We continue to see softer engagement in larger discretionary projects where customers typically use financing to fund the project.

Similarly, Pool Corporation says demand for new swimming pools is weak. But homeowners have not stopped projects altogether; it’s just the big items. Sherwin-Williams says paint demand is steady.

Discrimination is the theme. The American consumer is spending, but impulse is out. This is consistent with low unemployment paired with the exhaustion of excess pandemic savings, and a degree of shell shock from the big change in price levels (even though prices are no longer rising quickly). But the picture is decidedly not of a country sliding towards recession. A more likely outcome is tougher competition — and a degree of margin compression — for consumer companies.

(Armstrong and Reiter)

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