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The Disinflation Issue
The big news this week was the lower-than-expected CPI and PPI figures for July. While expectations for a September 50bp (0.5%) rate cut by the Fed changes on a daily basis, DKI agrees with current consensus that we’ll see a 25bp cut next month. We believe that’s premature and unwise, but still think that’s what’s coming. The best solution would be to reduce government spending, but no one in Washington DC is planning to do that, so prepare for more future inflation. Home Depot (NYSE:HD) and Walmart (NYSE:WMT) report good quarters, but are cautious in their guidance for later this year. Intel (NASDAQ:INTC) has a huge reliability problem with recent chips. DKI spoke with experts who disagree about the viability of the company’s x86 architecture. Some say it’s hit its end-point. Others think next year’s chips will be fantastic.
This week, we’ll address the following topics:
The CPI breaks 3% leading people to believe rate cuts are coming “sooner rather than later”.
June PPI came in high, but the July PPI was lighter than expected. Your conclusion: rate cuts coming “sooner rather than later”.
Home Depot has a good quarter, but gives disappointing guidance. Are higher interest rates hurting the home renovation market?
Intel has a huge problem. Its last two generations of CPUs are failing at a huge rate. Is this the end, or will next year’s Panther Lake save the company?
Walmart has an excellent quarter, but despite strong retail sales as reported by the Commerce Department, they express caution regarding the end of the year.
Ready for another week of obsessing about the fed funds rate? Let’s dive in:
CPI Softens, Rate Cuts “Sooner Rather than Later”:
Last Wednesday, we got the July Consumer Price Index (CPI) report which showed an overall increase of 2.9% for the last year and 0.2% for the month. That’s below last month’s 3.0% and expectations of 3.0%. The 0.2% monthly increase was above last month’s -0.1%. The Core CPI, which excludes food and energy was up 3.2% vs last year and up 0.2% from last month. Both of those were consistent with expectations. The annual number is still well above the Fed’s 2.0% target although there has been a clear trend in recent months toward disinflation. (Disinflation is a reduction in the rate of inflation.)
A clear and encouraging trend for the “doves” who want lower interest rates.
DKI Takeaway: In last week’s 5 Things, we noted a recent tick-up in the Manheim Used Car Index where prices rose from the prior month. I don’t think one month is a trend, but we also just saw an increase in goods inflation in last week’s PPI report. The Fed has struggled to reduce services inflation. If goods prices start to increase, they have a huge problem. On the other hand, the difficult to analyze employment market appears to be cooling, which is a result the Fed has actively been pursuing. The real issue right now is that everyone is looking for the Federal Reserve to “save” us from both inflation and a recession, but it’s Congressional spending that’s causing the problem. The market had set expectations for a September rate cut at 100% and many are expecting a 50bp cut next month. Based on recent data, DKI has shifted its position from “higher for longer” to rate cuts “sooner rather than later”. We expect a 25bp cut in September.
July PPI is Below Expectations:
The PPI stands for Producer Price Index. The reason it’s important as a measure of inflation is producers see price increases first. When those producers pass higher prices on to consumers, we experience that as inflation reflected in a higher CPI (consumer price index) or PCE (personal consumption expenditures). Last month, the June PPI was much higher than expected. July’s surprise went the other way with the PPI up 0.1% and the Core PPI flat vs last month. Expectations were for a 0.2% for both. Annual PPI inflation was a respectable 2.2% which was well below expectations of 2.6% and below last month’s surprisingly high 2.7%. The Core PPI was up 2.4% vs last year which was below last month’s 3.0%. That Core number is still a little high, but if the Fed is aiming for 2%, that 0.3% decrease is meaningful.
The PPI has been volatile, but the lower July number is again encouraging for the “doves”.
DKI Takeaway: Overall, this was a very positive report for those who want to see lower inflation and a lower fed funds rate. The one area of concern I saw in the report was a monthly increase in pricing for final demand goods of 0.6%. That’s a big increase, and one we warned about in last week’s 5 Things to Know in Investing. Much of that increase was offset by a decrease in pricing for previously sticky final demand services. This PPI report, combined with the below expectations CPI, make a September Fed rate cut highly likely.
Home Depot’s Guidance Disappoints:
Home Depot delivered strong earnings, reporting revenue of $43.2 billion, surpassing the expected $43.1 billion. The acquisition of SRS Distributions Inc. contributed an additional $1.3 billion to net income. However, the company's concerning guidance of a 3-4% sales decline through the end of the year has raised market concerns about the economic outlook in the housing and home improvement market.
Revenue has been more stable than some suggest, but concerns about future sales declines are legitimate.
DKI Takeaway: Economic headlines have been disturbing for the past few months. While aggregate data has been strong, DKI has warned about a bifurcated economy where most Americans aren’t doing great financially. Home Depot’s guidance is an example of how higher interest rates can cool consumer spending in debt-reliant markets like housing and renovations. This quarter, Home Depot saw a transition from small projects to large projects. Small home projects have a strong correlation to consumer strength. With some government stimulus programs ending, many consumers suffering from years of inflation do not have the funds to spend on updating their homes. Making things more challenging, inflation in housing is still increasing with 90% of the July CPI increase due to higher shelter prices.
Intel’s CPUs Keep Crashing:
Intel’s 13th and 14th Generation Central Processing Units (CPUs) have been encountering crashes. For those less familiar with semiconductors, CPUs function like the brain of your computer. Two years of Intel chips have been burning out due to faulty current controls. There is a patch to help unaffected chips, but if your CPU has failed, it can’t be fixed. Intel has been slow to help customers whose computers have failed through no fault of their own.
With over 60% of the PC market, your CPU could be affected.
DKI Takeaway: Intel has been struggling with negative press for weeks, and the outlook is negative right now. Over the past five years, AMD has steadily eroded Intel’s market share, and recent CPU failures could further accelerate this shift. Intel has acknowledged an issue related to excessive voltage being delivered to the processor. DKI spoke with multiple industry experts, and opinions are divided. Some say Intel’s x86 architecture has reached the end point of its capability and that the future leaders will be other options like the new ARM-based laptops. Others think it’s a temporary problem and are excited about big performance gains expected in next year’s Panther Lake CPUs. We'll continue monitoring to see how Intel addresses these challenges.
Walmart’s Earnings and Retail Sales:
Walmart’s Earnings and Retails Sales both show signs of a stronger than expected consumer. Walmart’s earnings surpassed analysts’ predictions, with revenue hitting $169.3 billion, compared to the expected $168.6 billion. The e-commerce business produced 21% growth. Like Home Depot, Walmart remains cautious about the remainder of the year's earnings outlook. That’s in contrast to the retail sales figure reported by the Commerce Department showing sales up by 1.0% on a seasonally adjusted basis. The largest growth factor in retail sales was in the auto sector.
The consumer will not be stopped!
We’ve seen some weaker data recently, but the July sales number was strong.
DKI Takeaway: Walmart's earnings reflect a shift in consumer behavior, with more people gravitating towards affordable stores. Despite inflation (or because of it), consumers are still spending, as they need to purchase necessities at rising prices regardless of economic conditions. Walmart's strong earnings benefit from food inflation and more people cooking at home instead of paying more to dine out or buying non-essential items. Excluding the significant increase in vehicle purchases, retail sales grew by just 0.4%. This suggests more bifurcation in the economy, with lower-income consumers turning to Walmart for essentials, while higher-income individuals continue to purchase cars and other more expensive items.
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