Pepcid for the PCE
Today’s consumption and spending report was a bit softer than expected. Both income and spending were solid at 0.3 and 0.4, respectively, but a tenth below expectations. More important both the headline and "core" PCE inflation rounded to a tenth.
As usual, I’m writing this note only after better measures of the core are released. Like in every month, the traditional “core” PCE deflator includes some wildly erratic items. This time it included monthly jumps in items such as equity security services (19%), used cars and trucks (2%) and falling items like newspapers and periodicals (-6%) and motor vehicle rentals (-2%). I still can't understand why a "core" measure would include so many volatile items.
As the chart below shows, the two better measures of core inflation—the median and trimmed mean—are mixed, with one running at an annual rate below 2% and the other still well above. The data continues to suggest some stickiness.
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Fed flop?
Some critics of the Fed argue that the soft number—yet again—caught the Fed wrong footed. “Just as the Fed turns hawkish, inflation softens.” I disagree. By the time of the Fed’s decision, both the CPI and PPI had been released and economists in and out of the Fed had a good idea what the PCE would be. For example, my former BofA colleague, Stephen Juneau correctly forecast that the month-over-month core number would round down to 0.1%, leaving the year-over-year increase unchanged at 2.8%.
The Fed’s hawkish turn and the market response to the message, brings them more in line with my own view all along. Growth remains resilient, and the final leg of the return to target inflation is proving challenging. I still see a pause in January and one or two 25 bp cuts in the first half of next year, followed by an extended hold.
Flexible inflation targeting
As expected, the Fed’s response to inflation stickiness has not been to either raise the target or to reverse the rate cuts. Instead, they are slowing the cuts and extending the forecast horizon for when they hit the 2% target. In September they expected to hit 2%--for both core and headline inflation—in 2026. Now they have moved out to 2027. The bigger picture here is that the Fed’s current framework has a modest dovish bias: a period of very high inflation is followed by a return to target. As a result, even over a ten year horizon inflation will continue to average a bit above 2%.
Retired strategist from the front lines to the reserves
3wThe increased lack of confidence in inflation falling to 2% over a 1-2 year horizon, rather than any short term number, seems to have spooked the Fed and thus those who adhere to its stance. Nearly half of economists expected 0.1% for core PCE, greatly due to a soft PPI health care indication, so it wasn’t a major surprise. Some components of Real PCE, especially spending at restaurants, were surprisingly soft.
Venture Developer, Board Member, Pre-Seed Investor
3wThe Treasury market does not agree with you, nor the Fed. Although your outlook and the SEP are rational, we have seen the Treasury market going from forecasting recession to forecasting multiple rate hikes. The Fed essentially follows the market in the long term, but the market is fickle.
Assistant Vice President, Wealth Management Associate
3wGreat insight