A little-noticed inflation report in the past could get a lot of market attention on Thursday
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With markets on edge over the direction of inflation, a report Thursday that often flies under the economic radar is likely to take on more importance. The Commerce Department’s measure of personal consumption expenditures prices could add to evidence that inflation is stickier than some economists and policymakers had thought. January’s reading is expected to show the cost of living still above the Federal Reserve’s target, despite nearly two years of tight policy aimed at arresting the trend. A popular measure among central bank officials, the so-called PCE often takes a back seat in importance among investors to the monthly consumer price index readings. But maybe not this time. “The number is going to be hot,” said Mark Zandi, chief economist at Moody’s Analytics. “Inflation doesn’t move in a straight line. It zigs and it zags, and it zagged in January.” Zandi expects the PCE price index to show a 0.4% increase for the month on both a headline and core level that excludes food and energy. The core increase would be double the growth in December and present another challenge for a Fed expected to take its foot off the monetary policy break at some point this year. Still, he thinks policymakers shouldn’t put too much emphasis on one number and instead look at the bigger picture, which he said shows inflation clearly easing . Zandi worries that keeping policy tight for too long could hit the economy hard. “They should just put this number on the side and say, ‘OK, this is why we’re not going to change interest rates at the next meeting, but it’s not going to have our expectations or forecasts for future rate cuts,” Zandi said. “Inflation is definitely decelerating. All the trend lines look good.” Though inflation has come off the boil from where it stood in mid-2022 — its highest in more than 40 years — an unexpectedly strong consumer price index reading in January jolted nerves on Wall Street. Several Fed officials followed up with indications that they are concerned about the path of inflation and will need to so more evidence of easing before approving rate cuts. “Expecting all data to speak uniformly is too high a bar,” Boston Fed President Susan Collins said in a speech Wednesday. “Still, it will be important to see sustained, broadening signs of progress toward the Fed’s dual mandate goals – while recognizing that progress may be uneven.” Collins added that while she still expects to cut rates this year, she figures the process to happen in a “methodical, forward-looking” manner and to happen “gradually,” rather than the aggressive pace of cuts the market had been pricing in previously. Market-based measures of inflation have indicated rising expectations. Two-year inflation breakevens, or the difference between Treasury yields and Treasury Inflation-Protected Securities, have surged in recent days. The benchmark 10-year Treasury yield has added nearly a quarter percentage point in February while the 10-year TIPS rate is up more than a quarter point. US10Y US10YTIP 3M line 10-year yield to TIPS Looking at the details PCE inflation gets more emphasis at the Fed than the Labor Department’s CPI report, which garners more attention from the public, primarily because it is considered a broader measure that takes into account changes in consumer behavior rather than just focusing on a fixed set of goods and services. Officially, the Fed follows the headline number, but officials tend to focus more on core as a better measure of longer-run trends. The CPI data as well as the producer price index, which also rose more than expected in January, feed into the PCE computations. Economists’ forecast a 0.3% monthly gain and a 2.4% 12-month move on headline, after rising 0.2% and 2.6% respectively in December, according to Dow Jones estimates. On core, the outlook is for 0.4% monthly and 2.8% annual rate, compared to 0.2% and 2.9% respectively the previous month, per the Dow Jones consensus estimates. However, it won’t just be the broader readings in play. Policymakers and market participants will be looking at the details for underlying trends. Among the key metrics will be housing and services indicators. “The key area that will really be a focus is that services portion of the PCE. But this print is most likely to confirm what we saw in the January CPI information,” said Michelle Cluver, senior portfolio strategist at GlobalX, which runs a $51 billion portfolio of global ETFs. “We really want to see disinflation flowing through into the services, as that’s the key element that’s essential to get to sustainable levels of inflation.” Should the PCE data confirm that inflation is still running above target, the attention then would turn to February and March reports, possibly pushing Fed cuts further out, Cluver added. Markets currently expect the first reduction to come in June or July. “If we continue to see hot data coming in through February and March, then I would start to raise caution about June as the first meeting” for a cut, she said. That in turn would raise concerns about the economic trajectory. Signs of trouble Zandi think if the Fed holds tough on tight economic policy it could pose a substantial danger to the expansion. “I’ve been a relative optimist about the economy, but I am growing a bit nervous about some of the vulnerabilities in the labor market and the financial system,” the Moody’s economist said. “The only thing keeping the labor market from falling apart is layoffs remain low,” he added. “But I think the labor market is a lot more fragile than people think. I’m growing increasingly worried the Fed makes a mistake and keep it’s foot on the economy for too long. And to what end?” A report Wednesday confirmed that economic growth was solid to close out 2023, with fourth-quarter GDP accelerating at a 3.2% annualized pace adjusted for seasonal factors and inflation. Though that was below the 3.3% initial estimate, it still showed that the bedrock forces of the U.S. economy, namely consumer spending and services, remained solid. In addition, the report showed that so-called chain-weighted expenditures adjusted for consumer behavior rose 1.8% on the quarter, the smallest gain since the Covid shock in the first quarter of 2020. Moreover, chain-weighted prices on goods actually declined 1.4%, the lowest reading since the second quarter of 2020 and indicative of actual deflation for a major portion of consumer spending.
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