Markets will get an updated look at the Fed’s preferred inflation gauge this week.

Spoiler alert: The YoY prints won’t be anywhere near target. And traders won’t be anywhere near caring.

Barring an anomalously hot MoM core PCE print or an extraordinarily robust read on consumption for February, markets will continue to focus on prospective rate cuts in the back half of 2023.

Traders are betting the legacy drag from last year’s policy tightening and the read-through for credit conditions from bank stress will ultimately overwhelm a stubborn US consumption impulse, pushing the economy towards recession. The US 2s10s is on track for the largest one-month steepening since 2008.

Remember: The inversion suggests a recession is 12-18 months out. The re-steepening suggests a downturn is 12-18 days out. I’m just joking. Sort of.

Although consumers are still spending, business investment is seen slowing sharply+, and housing remains a conundrum. Residential fixed investment was a drag on GDP for the last seven quarters, a streak that strongly indicates recession.

And yet, the bottom would have to fall out abruptly and completely to quell inflation in the near-term. It’s embedded on the services side of the economy, and flash reads on S&P Global’s PMIs suggested the related dynamics continued to entrench themselves in early March.

Consensus is looking for 0.3% and 0.4% from the headline and core PCE prints, respectively. The YoY readings should be somewhere in the neighborhood of 5.1% and 4.7%.

Analysts don’t expect the PCE data to show any progress on “services ex-housing,” the collection of categories Jerome Powell now favors as a gauge of underlying trend inflation.

I hate to put it this way, but I feel like it’s obligatory: There really hasn’t been any “progress” on inflation in developed markets, if “progress” is supposed to imply something about our capacity to effectuate changes in an unruly economic phenomenon.

I’m not feeling especially charitable today, so I’ll be even more blunt:

• If you were in the camp that said aggressive rate hikes could curb inflation if only central banks “had a backbone,” you were wrong. The Fed hiked as fast as they realistically could. The rate hikes haven’t done anything. Inflation is lower on a headline, YoY basis due to supply chain repair, normalization on the goods side (which had nothing whatever to do with monetary policy) and base effects.
• If, on the other hand, you were in the camp that said inflation was transitory and it’d moderate on its own if we just gave it enough time, you were wrong too. You can talk around it all you want, but inflation is entrenched on the services side of the economy. It’s found its way into wage-setting, and if it sticks around, it’ll find its way into expectations too.
• If you’re in the camp that looks to market-based measures to determine whether inflation expectations are anchored in the longer run, then God help you, because given geopolitical realities (not to mention climatic realities), those measures could turn out to be less than useless.

So, while some observers were certainly more right than others about whether inflation would accelerate to perilous levels, that’s where the prescient insight stopped. Inflation in developed markets took off two years ago. It’s still with us, and on some measures of the underlying trend, it’s getting worse, not better. The people who correctly predicted the return of inflation by and large suggested rate hikes were capable of containing it. What happened to that?

Our collective ineptitude to solve this problem is the furthest thing from surprising. Inflation, like all economic phenomena, has a human element. Several of them, actually. You can’t “solve for” human behavior and psychology. That’s why you don’t want inflation to migrate into services and wage-setting. Once it’s there, it’s virtually impossible to dislodge absent a shock to the system. The goods side isn’t any easier to “control,” so to speak, but the related drivers are more amenable to objective analysis. If plastic patio furniture is 50% more expensive than it was a year ago, some of that might be due to a hot housing market (i.e., more patios), but in all likelihood, the increase is explainable by logistical problems and maybe something to do with input prices for plastics. Some elements of services sector inflation can be explained the same way, but the number of subjective factors multiplies as you move further along the continuum from “pure goods” to “pure services,” if you will.

That’s where we are. The saving grace for the “rate hikes will fix it” crowd (the “because Volcker” contingent) is that eventually, rate hikes do have a good chance at working, only not in the neat, mechanical sense so many observers claim. Rather, rate hikes can work eventually because if you alter a fundamental input (in this case the cost of money) of economic decision making enough, you’ll invariably bankrupt (figuratively or literally) a few economic actors whose decisions were made based on the old settings. Depending on how important those actors are, their tribulations (or, in the most severe cases, their demise) can reset psychology and expectations among consumers and businesses by injecting a dose of acute, overwhelming apprehension.

Over the past three decades, various well-known disinflationary factors (globalization, automation, demographics, immigration and so on) lulled us all to sleep, and instilled a false sense of security regarding monetary policy’s capacity to “manage” price growth around a wholly arbitrary target. What we’re learning in the 2020s is that when even one or two of those factors is removed, managing price growth becomes more difficult, if not impossible. Goods prices surged due to pandemic dynamics, then commodities staged another rally in the wake of Russia’s Ukraine misadventures. By the time some of that started to fade, inflation had moved into services. Workers are consumers when they aren’t working, after all, and vice versa. The US economy is predominately services-based. There’s only so long workers will pay up for goods before they start demanding higher wages in their services-sector jobs. Those higher wages get passed along in the form of higher prices for services. Goods inflation might eventually wane, but by that time it doesn’t matter — it’s been supplanted by services inflation, and because labor costs are a huge percentage of service businesses’ costs, the whole thing becomes self-fulfilling.

February’s personal income and spending data in the US, as well as the PCE price prints, are “stale,” and we won’t know until next month if there was a meaningful impact from the bank failures on consumption. There are, of course, all manner of “real-time,” “high frequency” spending reports you can cite to make the case that the bank stress is already “working” to cool the consumption impulse, but the Fed doesn’t go by any of those. So, if you want to read about them and tweet about them, that’s fine, but it’s a waste of your time. Until any such deleterious trends show up in retail rales and PCE, it doesn’t matter for policy and even then, the Fed needs to see some evidence that the labor market is cooling.

The “good” news in all of this is that between misguided legislation, laughably bad regulation and the collision of a panicked hiking cycle with balance sheets built atop a collection of silly acronyms representing the 14-year perversion of capital markets (ZIRP, NIRP and LSAP), we now have bank runs and bank failures. Because all banks operate on liquidity and maturity transformation, bank runs are guaranteed to result in bank failures. And a rash of bank failures would surely do the trick when it comes to inflation, if left to run their “natural” course.

But, we can’t let bank failures run their natural course, because if we do, we chance an outcome where, although inflation might be solved, there are street protests, and riots and other kinds of social unrest which “never” happen in modern, developed economies (unless people finally lose their patience with the systematic murder of minorities by police or unless an aloof investment banker decides to unilaterally raise the retirement age by two years, to use a current example).

In addition to contingency planning for bailouts of uninsured deposits and unpalatable inflation data, US investors can look forward to figures showing that the rate at which home prices are becoming more unaffordable slowed in January, as well as speaking appearances by a handful of people who’ll explain that their “tools” are more than sufficient to contain the inflation and bank runs that those same tools helped create and facilitate.