Amid hotter-than-expected inflation readings, the Federal Reserve is grappling with what officials describe as a “bumpy” path toward achieving their 2% inflation target. This week’s impending data release will further shape the narrative.
Economists project that the Federal Reserve’s preferred inflation measure, the “core” Personal Consumption Expenditures (PCE) Index, excluding volatile food and energy prices, will record a year-over-year increase of 2.8% for January. While this is slightly lower than the 2.9% registered in December, the expected month-over-month increase of 0.4% (up from 0.2% in December) raises concerns about the pace of inflation decline, potentially pushing the six-month and three-month annualized inflation figures above the Fed’s 2% target, warns Bank of America.
Investors are closely monitoring the new PCE reading to gauge the Federal Reserve’s stance on loosening its monetary policy after an aggressive campaign to curb inflation, reminiscent of efforts in the 1980s.
At the start of the year, markets bet on six rate cuts beginning in March, but sentiments shifted to three cuts starting in June following cautious commentary from Fed Chair Jerome Powell and higher-than-expected inflation readings.
The recent inflation data, with the Consumer Price Index (CPI) in January exceeding expectations, alongside the Producer Price Index (PPI) showing increased costs for businesses, has stirred caution among Fed officials. The correlation between PPI and PCE introduces the risk of a higher-than-expected PCE reading.
Wilmer Stith, bond portfolio manager for Wilmington Trust, suggests that if the PCE number is high and U.S. jobs numbers continue to outperform expectations, the Fed might choose to maintain higher rates for an extended period.
While some Fed officials acknowledge the “bumpy” trajectory, others express caution in the face of rising inflation. Fed governor Chris Waller questions whether the January data represents a mere “speed bump” or a more serious “pothole,” advocating for a patient approach in assessing the need for rate cuts.
Fed governor Michelle Bowman emphasizes that the Fed isn’t at a point to initiate rate cuts and that a rapid reduction in rates could necessitate a future rate hike. She also hints at the possibility of raising rates if progress on inflation stalls or reverses.
Kansas City Fed president Jeff Schmid, in his recent speech, emphasizes that challenges in addressing high inflation persist. He attributes the current decline to lower goods prices as supply chains recover from pandemic disruptions. Schmid anticipates continued rapid increases in services prices, constituting a significant portion of consumer spending.
Despite optimism surrounding the decline in inflation, Fed officials remain cautious about prematurely adjusting policy stances. The anticipated rise in the PCE for January aligns with views embedded in Fed officials’ outlook, with expectations for the first cut to occur at the June meeting and not before, according to Matt Luzzetti, US chief economist for Deutsche Bank Securities.
