The Federal Reserve’s stance during its June meeting and Chair Jerome Powell‘s remarks about needing “more confidence” might have shifted if policymakers had also seen the largest drop in producer inflation in eight months.

In May, the Producer Price Index (PPI) decreased by 0.2% on a monthly basis, marking a significant drop from April’s 0.5% growth and missing the expected increase of 0.1%. It marks the lowest monthly PPI print since October 2023.

The decline in the overall index in May was driven by energy prices, which fell by 4.8%, the worst performance since October 2023. Notably, gasoline costs decreased by 7.1%.

However, it wasn’t just energy that contributed to the cooling of wholesale price pressures. When excluding food and energy items, the core PPI was flat on a month-over-month basis, down from the previous 0.3% increase and missing the expected 0.3% rise. Transportation and warehousing services were particularly weak in this category, falling by 1.7% on a monthly basis.

The annual variations in both headline and core PPI indices also fell short of estimates, adding to the cooler-than-expected consumer inflation data released just a day earlier.

Economists and market participants weighed in to explain what this data may mean for the Federal Reserve’s policies going forward.

Fed Eyes Rate Cuts, Experts Believe

Chris Zaccarelli, chief investment officer for Independent Advisor Alliance, highlighted the market’s positive reaction to the inflation data, stating, “Yesterday, the market reacted very positively to the lower-than-expected inflation in the CPI report and this morning's PPI report is more data in the correct direction – significantly lower-than-expected inflation, so the follow through should be positive again.”

The expert believes that after some inflation disappointment in the first quarter of the year, the latest figures strengthen the case for a potential Fed rate cut in late 2024.

According to Bank of America’s U.S. economist Michael Gapen “the report supports the view that disinflation is the most likely path forward.”

Gapen believes recent inflation data greatly reduces the likelihood of rate hikes and suggests that while an easing cycle beginning in September is possible, a December cut is more likely. He added, “We think that the Fed will need to see more than just a few months of favorable inflation data to gain enough confidence to ease.”

Bill Adams, chief economist for Comerica Bank, echoed the sentiment of cautious optimism, stating, “The downside surprise from producer price inflation reinforces the message of the May CPI report.”

Adams highlighted that both food and energy prices fell, and service prices were flat due to a drop in transportation and warehousing rates. He suggested that the data supports expectations for a softer reading of the Fed's preferred inflation measure, the personal consumption expenditures price deflator, and hinted at possible rate cuts starting in September.

Jeffrey Roach, chief economist for LPL Financial, emphasized the broader perspective, noting that the decline in producer prices brought the annual rate down to 2.2%, close to pre-pandemic trends.

Roach commented, “The decline this month is a bit of a payback from the outsized gain in April, so that should keep it in perspective.” He expects future inflation reports to solidify the Federal Reserve’s view, potentially leading to rate cuts later this year if sticky components show signs of easing.

Clark Bellin, president and chief investment officer at Bellwether Wealth, sees the PPI data as a positive signal for inflation progress, saying, “Thursday’s weaker-than-expected PPI data is another sign of continued progress on inflation, and it keeps the prospect of a rate cut alive in 2024.”

Bellin noted the stock market’s current highs, driven by expectations of disinflation and corporate earnings growth. He added that there are numerous investment opportunities available, particularly in stocks, high-yield money markets, and fixed income, suggesting investors move away from cash to capitalize on these yields.

What Is The Market Pricing In?

Market participants are currently assigning a 67% chance on a September rate cut, according to CME Group’s FedWatch tool.

Fed futures are indicating 52 basis points of rate cuts – thus two fully priced cuts – by year-end.

These updated rate cut expectations have pushed bond yields lower, with the 10-year benchmark Treasury yield eyeing the lowest close since late March 2024.

The iShares 20+ Year Treasury Bond ETF ( TLT ) is up by 1.8% this week, on track for the best weekly performance in more than a month.

Read now: Fed Chair Powell Tempers Market Excitement: ‘We Want To Gain Further Confidence’ On Inflation