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The future inflation trend in the United States is the core factor affecting the Fed's interest rate cut decision this year, given its data dependence. In this report, we update and refine the "six-point method" framework for US CPI inflation previously constructed to more accurately predict future US inflation trends.

How is the prospect of American reserves? The US financial environment has tightened since the beginning of the year, and US reserves have suffered setbacks (with May's ISM manufacturing PMI falling), but the S&P 500's US manufacturing PMI in May rose to 51.3% and still maintained a rising trend. Looking ahead, although this round of reserves is not "active" against the backdrop of weakening commodity consumption, its intensity is weaker than the previous round, but we believe it still has the potential to accelerate, mainly for the following reasons: 1) the interest rate cut expectation is expected to improve the financial environment; 2) durable goods new order data continuously exceeds expectations; 3) the S&P 500 EPS growth rate is still on the rise.

In order to explore the relationship between reserves and inflation, we divide reserves into "quantity" and "price".

"Quantity" of reserves does not directly cause commodity inflation. First, it is necessary to clarify that the "quantity" of reserves does not directly cause commodity inflation. The increase in actual inventory "quantity" is a manifestation of supply exceeding demand and should have a mitigating effect on commodity inflation rather than pushing it up. 1) Can the demand for upgrading lead to a renewed upswing in US consumer durable goods consumption? For durable goods, the characteristic of "consumer demand dominance" means that the growth rate of actual inventory will be slightly lagging behind CPI inflation, and instead, inflation will lead the growth rate of inventory. So what is the outlook for US durable goods consumption this year? According to the average service life of US durable goods of 3-5 years, the next peak of US durable goods upgrading demand seems to be coming soon (the last time was in 2020). 2) The core constraint on durable goods consumption: actual household income. We do not deny that there may be periodic fluctuations in US durable goods consumption due to upgrading demands, but durable goods consumption also depends on income and interest rates. Overall, this year's US household income (increased tax payments + wage growth rate slowdown) will obviously become a "headwind" dragging down durable goods consumption, and the high interest rates at present will not be conducive to durable goods consumption. Therefore, it is difficult for US durable goods consumption to rebound significantly this year, which will also drag down durable goods inflation.

The transmission of the "price" of reserves: the upstream price transmission of the core non-durable goods is more significant. For the "price" of reserves, it represents the channel through which US reserves transmit from upstream costs to downstream consumer prices, which is mainly reflected in PPI (production cost) and import prices (US consumer goods depend on imports).

1) The difference between US PPI and CPI is huge and needs to be analyzed from bottom to top, which means that corresponding analysis needs to be carried out on the structure of the two.

2) Energy and food CPI: both reflect PPI and import price transmission.

3) The relationship between US core commodity PPI and CPI has weakened in the past 20 years and needs to be further broken down for analysis. The rise in US core commodity export PPI may mean that the core consumer goods PPI part may rise in the future, mainly because US exports are biased toward upstream while consumer goods are biased toward downstream. However, we need to further break down the core commodities into durable goods and core non-durable goods.

4) CPI of durable goods: not strongly related to PPI and import prices. On the one hand, the large fluctuations in US durable goods demand make the CPI inflation of durable goods passively transmit to upstream PPI and import prices. On the other hand, the previous round of globalization caused the production chain of durable consumer goods to be scattered and production competition to be fierce, making it difficult for PPI production costs and import prices to be directly passed on to consumers.

5) Core non-durable goods CPI: import prices point to the possibility of its future inflation. PPI leads the core non-durable goods CPI by about 5 months, and import prices, as well as oil prices (which account for a large share of the cost structure of core non-durable goods), all point to the possibility of "re-inflation" of US core non-durable goods in the future.

Conclusion: durable goods inflation depends on demand, while core non-durable goods inflation depends on the upstream. 1) Risks to durable goods consumption dragging down or persisting inflation come from the global supply chain and may affect the global supply chain. From a mid-term perspective, US vehicle inventory and Manheim used car price index are still the best observation indicators, but neither of these point to a significant rebound in durable goods inflation in the short term.

Risk Warning: Excessive tightening of Fed, fiscal policy or weakening impact of US household income on expenditure

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1. How is the prospect of American reserves?

Will US reserves cause "re-inflation" of commodity CPI? In 2024, the US reserves replenishment cycle will restart, and US PPI will show a rising trend. The market is concerned whether this means that US commodity CPI inflation will rise, especially whether the core commodity part will show a "re-inflation" trend after experiencing "deflation" in 2023. We conduct a detailed analysis of this.

Since the beginning of this year, the American financial environment has tightened, and the replenishment of American stocks has encountered setbacks, but as long as the economy does not fall into recession, replenishment is still the benchmark assumption for this year. In our previous report, we warned about the prospect of American manufacturing recovery/stock replenishment prospects. In addition to the fact that the speed of inventory growth has fallen to a low level, the gap in the American manufacturing PMI (new orders - own inventory) and the relaxation of the American domestic financial environment are also leading indicators of replenishment. Since the first quarter of this year, there have been ups and downs in American manufacturing PMI data. In particular, the May ISM caliber fell to 48.7, mainly due to the weakening of American residents' commodity consumption momentum and the tightening of the American financial environment. However, the S&P 500's May American manufacturing PMI is different from the ISM, but it has risen to 51.3, still maintaining a trend of recovery, so it is not yet possible to judge that American manufacturing replenishment/production recovery has undergone a reversal.

Looking forward, although this round of replenishment is not "active" in the context of weakening commodity consumption, the replenishment intensity is weaker than the previous round, but we believe that it still has the potential to accelerate, mainly for the following reasons: 1) The expected rate cut is expected to improve the financial environment. In the second quarter, the 10-year US Treasury bond yield has entered a consolidation period. Although it is still at a high level, the expected rate cut of the Fed has increased, which is conducive to the relaxation of the financial environment. 2) The new durable goods order data continues to exceed expectations, showing that the upstream production department's demand is still relatively strong, and the S&P caliber American PMI report also mentions that the demand for investment goods is relatively strong; 3) The EPS growth rate of the S&P 500 in the United States is still on an upward trajectory, and corporate profits are strong. There is ample room for US corporate capital expenditures.

Structurally, durable consumer goods inventories are not only higher than non-durable goods, but consumer demand is also largely suppressed by income and high interest rates. Therefore, this round of American commodity replenishment may be more focused on non-durable goods, and upstream manufacturing replenishment may not only be due to inventories reaching a low level. The construction spending driven by the American manufacturing return policy in the past few years may also be an important factor driving manufacturing replenishment.

2. The "quantity" of replenishment will not directly cause commodity inflation.

To explore the chain between replenishment and inflation, we divide replenishment into "quantity" and "price".

First of all, it should be clarified that the "quantity" of replenishment does not directly bring about upward inflationary pressure. Regarding the former "quantity", we believe that it itself will not cause commodity inflation to rise because the actual increase in inventory "quantity" is a manifestation of supply and demand, which should have a moderating effect on commodity inflation rather than pushing it up.

For durable goods, the feature of "consumer demand dominance" means that the actual inventory growth rate will lag behind CPI inflation slightly. We also observe that there is a certain correlation between durable goods inflation and actual inventory growth rate in the wholesale industry, which may be due to the large fluctuations in durable goods consumption, pushing the two together, reflecting the demand-driven durable goods inflation, and consumer demand will also stimulate inventory replenishment, Therefore, durable goods CPI inflation may show a slight leading state over inventory growth rate, which means that durable goods inventory and inflation do not have a causal relationship between each other.

2.1 Can the upgrading demand revive American durable goods consumption?

As mentioned above, for durable goods, American resident consumer demand may be more important, so what is the future trend of consumption?

Can the upgrading demand revive American durable goods consumption? As mentioned above, American durable goods consumption will transmit to durable goods CPI and actual inventory, and it is one of the decisive factors of the two. So, what is the outlook for American durable goods consumption this year? First of all, under the stimulus of pandemic-suppressed service consumption and fiscal subsidies, American durable goods consumption peaked in 2020. According to the average service life of American durable goods (3-5 years), the next wave of American durable goods upgrading demand peak seems to be imminent, does this mean that actual American durable goods consumption will experience a sharp rebound?

2.2 The core constraint of durable goods consumption: actual resident income

We do not deny that American durable goods consumption may have periodic fluctuations caused by upgrading demand, but durable goods consumption also depends on income and interest rate factors. Overall, American resident income will obviously become a "headwind" that drags on durable goods consumption, with strong certainty. The current high interest rates are also not conducive to durable goods consumption (but if interest rates fall, they can stimulate durable goods consumption to a small extent), so American durable goods consumption is difficult to rebound sharply this year. This will also drag on durable goods inflation.

The increase in taxes and the slowdown in wage growth of American residents are likely to continue to drag on the growth rate of American residents' actual income in 2023 and may continue to drag on durable goods consumption. There are two main reasons: 1) The amount of taxes paid by American residents rebounded in 2024, which in turn caused the positive contribution of the growth rate of American residents' actual income in 2023 to turn negative this year. 2) American residents' wage income has continued to decline under the influence of the relaxation of the job market. The contribution of employee compensation to the growth rate of resident income is also declining. The weaker job vacancy recently announced confirms this point.

3. The transmission of the "price" of replenishment: non-durable goods are more significantly affected by upstream prices.

Regarding "price", it represents the channel through which American replenishment transmits upstream costs to downstream consumer goods prices. This is mainly reflected through PPI (production cost) and import prices (American consumer goods depend on imports). For the former, the market has long debated the transmission chain from PPI to CPI. Therefore, we first clarify the relationship between PPI and CPI.

3.1 The difference between American PPI and CPI is huge, and analysis is needed from the bottom up.

There are several differences between the American PPI and CPI that make it difficult for us to simply and directly regard the year-on-year increase of the American PPI as a signal for the year-on-year increase of the American CPI, but rather we should correspond to them structurally: 1) Only the private consumption part of American final demand PPI is directly related to CPI. American CPI only targets resident consumption costs, while American PPI covers demand-side areas such as resident consumption, government purchases, private equipment, exports, etc., so the part of PPI related to CPI is its resident consumption part.

PPI doesn't measure import prices, which is why we need to pay attention to import price indexes at the same time. The US CPI not only measures domestically produced consumer goods but also includes imports, which are not included in PPI. Therefore, sub-items with a large proportion of imports in CPI, such as apparel, cannot be fully explained by PPI.

PPI does not include virtual rent with high weight in CPI, and other services have a weak relationship with CPI. The sub-item of owners’ equivalent rent, which accounts for about 25% of the weight of CPI, is not included in PPI because this part of the "virtual rent" is not produced. Even after removing the rent lag, the relationship between the US service PPI and the US core non-rent service CPI is not strong.

Other differences between the two include incomplete coverage of services in PPI and different sub-item classifications.

Energy and food CPIs reflect PPI and import price transmission.

Due to the high dependence of U.S. consumption on imports, we analyze import prices, PPI, and CPI together. For energy and food sub-items, we have found that import prices and PPI have a strong transmission effect on CPI. The prices of these two items have begun to rise since the end of last year.

There is no time lag between fuel import prices and energy PPI to energy CPI, indicating that US energy inflation is directly transmitted by global oil prices. This is true for both import prices and energy production costs.

The price of food imports and agricultural PPI lead household food CPI by about 3-4 months, but the CRB and FAO food indexes mentioned in our report on US inflation risks last year ("US inflation risks and analysis framework for CPI's "six-part method", and outlook for 2023," March 13, 2023) are still leading indicators for US food CPI (9 months), which shows that global pricing still dominates US food inflation and there is indeed room for food inflation to rise in the US.

The relationship between US core commodity PPI and CPI has weakened over the past 20 years and needs to be further analyzed and broken down.

The increase of US core commodity PPI (export) may mean that the PPI of some core consumer goods may increase in the future. As we analyzed earlier, the relationship between US core non-rent service CPI and PPI is not strong, but food and energy are affected by PPI transmission. In terms of core commodity CPI (excluding food and energy), we also need to emphasize that only part of the consumer goods in US core commodity PPI correspond to CPI core commodities, and other private equipment, government procurement, and export parts are not related to CPI consumer goods. However, we found that the US core commodity PPI shows a clear relationship in which export sub-items lead government purchasing, private equipment, and consumer goods, which may be due to the larger proportion of minerals and metal products (upstream) in the US export structure, while private equipment and government procurement tend to be midstream capital goods, and consumer goods tend to be downstream. Recently, the export part of the US core commodity PPI points to the consumer goods part of the future core commodity PPI, which may rebound.

However, we found that the relationship between the consumer goods part of the US core commodity PPI and the core commodity CPI has greatly weakened since 2000. Therefore, the upward risk of the former cannot be simply equated with the latter. Therefore, we need to split the core commodities into durable goods and core non-durable goods.

Durable goods CPI is the main factor that differentiates the trends of core commodity CPI and PPI after 2000. Even the trend of durable goods import prices does not correspond one-to-one with that of durable goods CPI. We believe that there are mainly two reasons:

1) US durable goods demand fluctuates greatly, especially since the outbreak of the pandemic, US residents' income and savings have increased, making durable goods CPI inflation actively transmitted to upstream PPI and import prices. Durable goods consumption fluctuates greatly, far exceeding that of non-durable goods, so the inflation of US durable goods CPI can even actively transmit to upstream import prices and PPI production costs. The most obvious example is that since the outbreak of the pandemic, US durable goods CPI inflation has peaked earlier than durable goods PPI and durable goods import price index.

2) In the last round of globalization, the production chain of durable consumer goods was dispersed (to minimize costs), the production competition was fierce, and with the large fluctuations in US durable consumer goods, consumers had strong bargaining power. Thus, PPI production costs and import prices were difficult to pass on directly to consumer prices. This was especially true before 2008.

For core non-durable goods, we found that PPI and import prices lead CPI by about 5 months and 9 months respectively, and both have a close relationship with CPI, highlighting that the demand for core non-durable goods does not change much, and CPI inflation is determined by upstream costs. Although PPI has not shown a rebound trend yet, we found that the more leading import prices and oil prices (which occupy a large proportion in the cost structure of core non-durable goods) all point to the future possibility of further inflation of core non-durable goods in the US. In addition, the inventory of core non-durable goods in the US wholesale industry is significantly lower than that of durable goods, which also shows a relatively stronger demand for inventory replenishment in the future, corresponding to the increase in import prices of core non-durable goods.

Summary: for durable goods inflation, we should look at demand, while for core non-durable goods inflation, we should look upstream.

For core non-durable goods, we found that PPI and import prices lead CPI by about 5 months and 9 months respectively, and both have a close relationship with CPI, highlighting that the demand for core non-durable goods does not change much, and CPI inflation is determined by upstream costs. Although PPI has not shown a rebound trend yet, we found that the more leading import prices and oil prices (which occupy a large proportion in the cost structure of core non-durable goods) all point to the future possibility of further inflation of core non-durable goods in the US. In addition, the inventory of core non-durable goods in the US wholesale industry is significantly lower than that of durable goods, which also shows a relatively stronger demand for inventory replenishment in the future, corresponding to the increase in import prices of core non-durable goods.

For durable goods inflation, we should look at demand, while for core non-durable goods inflation, we should look upstream.

Durable goods consumption may drag or sustain inflation, and risks come from global supply chains.

In summary, we have not yet observed significant rebound in US durable consumer goods import prices or PPI, and according to the previous discussion, there is not a strong correlation between the two and US durable goods CPI. In addition, with the continued pressure on US durable goods consumption this year (income, high interest rates), whether US durable goods inflation can heat up this year needs to be continuously observed. One possible risk comes from geopolitical risks, which may affect the global supply chain and thus push up durable goods inflation. From a medium-term perspective, US vehicle inventory and the Manheim used car price index are still the best observation indicators, but neither of them points to a rebound in durable goods inflation in the short term.

Core non-durable goods inflation of 4.2% may lag behind the rebound in import prices.

Core non-durable goods inflation may lag behind the rebound in import prices. For core non-durable goods inflation, although it may be worry-free for a few months in the short term, according to import prices, core non-durable goods inflation at the end of this year may become another "timed bomb" that affects the market's expectation of a Fed rate cut. On the other hand, due to the comprehensive impact of import prices and PPI production on inventory, we can also see from the GDP inventory price (deflator) that the core non-durable goods inventory price has a leading relationship with core non-durable goods CPI, pointing to a possible rebound in future core non-durable goods CPI.

The market usually ignores core non-durable goods consumption and inflation because their demand changes are often weaker than durable goods'. However, with the Fed's rate cut expectation continuing to fluctuate back and forth this year, if the year-on-year contribution of US core non-durable goods to CPI can rebound from the current low point of 0.1 percentage points in the fourth quarter of this year, it can correspondingly push up the overall pressure of US CPI and affect subsequent Fed rate cut decisions.

Risk Warning: The Fed's tightening measures exceed expectations, US fiscal tightening measures exceed expectations, and the impact of US residents' income on spending weakens.

Edited by Jeffrey