Following the release of the CPI data, the market widely anticipates that this favored indicator of the Federal Reserve will 'take off.' Has an interest rate cut within the year become a distant hope? Additionally, this data was released prior to the outbreak of the Middle East conflict...
At 8:30 PM Beijing time on Friday, the United States will release its January PCE price index. The market expects that the PCE data will increase by 2.9% year-over-year, consistent with the previous figure, and rise by 0.3% month-over-month, slowing down from the 0.4% increase in the previous month. Regarding core figures, the market anticipates that the year-over-year growth rate of the core PCE price index will slightly accelerate to 3.1%, marking the largest increase since April 2024, while the month-over-month increase remains unchanged at 0.4%.
Ask Futubull AI:Please provide the potential market reactions and corresponding operational strategies under different scenarios for the January U.S. PCE data.
Is the PCE bound to rise?
As the 'flagship' data from the U.S. Bureau of Economic Analysis, the PCE price index directly references CPI data across several price categories. Following the release of the latest CPI data, economists swiftly raised their forecasts for the core PCE price index for February, which is set to be released on April 9. Several economists predict that the index will rise by 0.4% for the second consecutive month, while some are even bracing for a larger increase.
This divergence stems from the differing weight allocations assigned to specific items by each inflation metric. The CPI, compiled by the U.S. Bureau of Labor Statistics, places significant emphasis on housing costs. A key indicator known as 'primary residence rent' has risen by only 0.1% since January, representing the lowest level in five years. Additionally, it assigns a higher weight to used car prices, which have now fallen for three consecutive months.
On the other hand, the PCE price index places greater importance on the costs of certain specific goods. Economists noted that products such as computer software and jewelry showed significant increases in the February CPI, and they carry more weight in influencing PCE inflation. Forecasters from Barclays, Morgan Stanley, and Bank of America anticipate that core goods prices in the PCE for February will rise by at least 0.8%, ten times the increase shown in the latest CPI report.
A startling phenomenon
A detailed analysis of the CPI data overlapping with the PCE reveals that not only was the situation for January concerning, but the outlook for February’s PCE data also appears unpromising. Moreover, all of this occurred prior to the outbreak of the U.S.-Iran war, which caused surges in energy and fertilizer costs among others.
Furthermore, what warrants attention is a shocking phenomenon observed in the two primary indicators measuring price levels faced by U.S. consumers: the PCE data, which has almost always been more 'moderate' compared to the CPI, is now showing a sharp increase.
Economists expect that core PCE grew by 3.1% year-over-year in January, compared to just a 2.5% increase in core CPI for the same month, which marked the lowest level since the surge in inflation during the spring of 2021. Meanwhile, the price data for February released on Wednesday showed that CPI growth remained at this low level.
What concerns dovish observers is that when inflation began to take off in 2021, the PCE indicator actually started climbing ahead of the CPI. If the core PCE for January indeed rises as economists predict, the gap between its year-over-year increase and that of the core CPI would mark the largest disparity in decades.
The Fed's Dilemma and New Variables Introduced by the War
This is also very likely to cause policymakers to diverge. The Trump administration has already capitalized on the CPI report, claiming that price pressures are under control and that the Federal Reserve should significantly cut interest rates. Meanwhile, hawks within the Fed have pointed to the PCE indicator to counter that inflation remains a full percentage point higher than the 2% target set by policymakers.
Citi economists explicitly stated that the PCE data “should keep Fed officials cautious about inflation risks and hold steady for now.”
As this debate remains unresolved, the outbreak of the U.S.-Iran war has added another layer of complexity to an already intricate situation. The sharp spike in oil prices will be directly reflected in March’s inflation data; the jump in diesel prices will push up transportation costs; and disruptions to fertilizer supplies in the region are expected to further drive up food prices.
Elizabeth Renter, senior economist at NerdWallet, noted: “The longer the conflict persists, the greater the risk of pushing up overall inflation.”
Economists at Bank of America also pointed out that while CPI data appears moderate, PCE inflation does not provide a stronger case for rate cuts, especially considering the upward risks posed by oil prices.
This places the Federal Reserve in a genuine dilemma. A softening labor market should theoretically support rate cuts, but if the PCE remains strong and energy and food price shocks from the war arrive simultaneously, officials will find it difficult to justify restarting an easing cycle.
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