The schedule’s pretty crowded this week in the US. An update on the Fed’s preferred inflation gauge is the marquee macro event.
Core PCE price growth probably ran at 0.4% in January, double December’s monthly pace, economists reckon. Suffice to say overshoots on CPI and PPI shifted the narrative. And meaningfully so.
The PCE release will likely confirm that the disinflation process stalled last month. The Fed might not characterize it that way, but the word “stall” is in their vocabulary. It made two cameos in the January FOMC minutes, both times to describe a prospective loss of momentum in the battle to restore price stability.
As the figure suggests, 0.4% MoM prints aren’t tenable. Generally speaking, these monthly readings need to be under 0.2% if the Fed wants to get inflation down to 2% YoY. Note that 0.4% would count as the largest sequential gain in a year.
One month doesn’t make a trend, but nobody’s going to be cutting rates with those type of month-to-month readings on core inflation. Consider this: At the extremes last month, markets had the March FOMC meeting priced at 80% — so overwhelmingly priced for a cut. Now, the market-implied odds of a move in May are just 20%. Goldman pushed back their call on the first cut to June, for whatever that’s worth (nothing). They expect four cuts for the year (at the June, July, September and December policy gatherings).
If the PCE update comes in as expected, the three- and six-month annualized measures market participants cited to make the case for a March cut would both move back above 2%. At last month’s press conference, Jerome Powell said that while the Fed welcomed the progress, below-target readings on the shorter lookbacks weren’t in and of themselves sufficient to convince the Committee.
Fortunately for market participants whose only concern is stocks, equities stopped caring about 2024 rate-cut pricing weeks ago. Who needs rate cuts when you’ve got Nvidia?
The figure above is a modified version of a stylized representation I’ve employed fairly often in 2024. What it suggests, in a nutshell, is that whatever momentum stocks might’ve lost in the new year as rate-cut wagers faded was more than offset by Nvidia’s rally.
Of course, there’s a macro narrative too. The story now goes as follows. A resilient economy and a trio of insurance cuts is actually the best-case scenario. This is a Fed which, while reluctant to turn the screws any tighter despite copious evidence to suggest the neutral rate’s higher, is nevertheless predisposed to holding terminal for an extended period in light of PTSD from the inflation shock. Convincing this Fed to cut rates five or six times in 2024 would require a significant deterioration in the macro environment, and that’d be deleterious for corporates and thereby stocks. So, better three cuts and no recession than five or six cuts with a downturn. So say record-high equities. If you get the idea that stocks (and, more aptly, the people who trade them) are just goal-seeking a narrative to justify the rally, you’re not wrong.
The incoming Fed rhetoric in unequivocal: Rate cuts aren’t imminent. That said, it’s important to properly characterize market speculation about another hike. Those wagers are hedges more than anything else. “Another hike isn’t on the table, nor do we expect it will realistically be at this stage in the cycle,” BMO’s Ian Lyngen and Vail Hartman wrote. “We’re not making the case that nudging terminal up by 25-50bps over the course of 2024 doesn’t have some degree of merit, rather that when weighed against the credibility risk and other macro crosscurrents, the Fed is more likely to hold terminal in place for longer than previously assumed.”
That’s a good assessment. Read it again. The Fed’ll always say they “won’t hesitate” to set policy as needed to achieve their goals, but hesitate they most assuredly would in the event the Committee came to the conclusion that an additional hike may be warranted. Another increase would be an explicit admission that the Fed misjudged “sufficiently restrictive” and a de facto admission that the neutral rate’s higher. It could also erode confidence in the Fed as an institution even if it ostensibly underscored their commitment to the price stability mandate. And then there’s the (high) odds of a policy mistake, whereby the long-delayed recession finally comes knocking and critics ask, “Was that last rate hike really necessary?”
The PCE update will also be watched for evidence that the bulletproof American consumer did in fact retrench in January consistent with the message from a lackluster retail sales report. That’s all on Thursday. On Wednesday, the second estimate of Q4 GDP will garner a few headlines. Upward revisions would argue for a longer stay at terminal, whereas any downward revisions probably wouldn’t shift the narrative.
Also on deck in the US: Updates on the national home price indexes (which’ll be contextualized by overshoots on some gauges of shelter inflation), new and pending home sales (on the heels of the first meaningful existing home sales uptick in 11 months) and ISM manufacturing (which may offer additional evidence to suggest America’s prolonged factory downturn is now over).
Elsewhere, this month’s flurry of European inflation data comes due, culminating Friday with the bloc-wide release. Japan will also update its central bank on price growth as Kazuo Ueda mulls a somewhat awkward conjuncture defined by a recession, the first Nikkei record in 34 years and market expectations for the first rate hike since 2007.
