Does Inflation Data Signal a Fed Pause?

Friday, April 28, 2023

This morning, the U.S. Bureau of Economic Analysis (BEA) reported the latest Personal Consumption Expenditure (PCE) inflation data and it came broadly in line with the consensus of a slight cooling.

PCE is a measure of inflation that tracks the changes in the prices of goods and services purchased by consumers throughout the economy. The core PCE deflator, which strips out food and energy prices, and is thought to be the Fed’s preferred inflation metric, came in at 4.6%, down marginally from an increase of 4.7% at the end of February. This is slightly higher than the 4.5% economists were expecting. The 0.3% increase month over month was the same level seen in February. The headline PCE deflator decelerated to 4.2% year over year, down from last month’s upwardly revised year-over-year rate of 5.1%. Month over month inflation was the softest since July 2022.

Looking closer into the data the economy is still experiencing a dichotomy between goods inflation and services inflation but at least both growth rates are declining. Services inflation increased 5.5% in March from a year ago, while goods inflation rose 1.6% during the same time period, but both growth rates are lower than the previous month. Adjusted for inflation, consumer spending was unchanged from February, while personal income rose 0.3%. Energy prices slid 3.7% month over month and food costs fell 0.2%, which should release some pressures on household budgets.

We have updated our Inflation Dashboard below with the latest PCE data: core services prices excluding housing showing signs of easing at a noteworthy clip. Only one of our dashboard indicators (CPI-U: Rent of primary residence) now remains at an extremely elevated level).

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While the Federal Open Market Committee (FOMC) is still expected to implement a 25 basis point (0.25%) hike at next week’s May meeting, the situation shown in the chart below, where the fed funds rate is above both headline and core PCE, adds credence to the view that May’s likely hike could be the final flourish at the end of the Fed’s current rate hiking cycle. The widening of the difference between the fed funds rate and inflation will be a key topic for the remainder of 2023 as we assess the potential for, and timing of, rate cuts.

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In a recent CNBC interview, Federal Reserve Bank of Atlanta President Raphael Bostic, who is a currently a non-voting, but still influential, member of the FOMC, suggested a pause after May, as he stated “One more move should be enough for us to then take a step back and see how our policy is flowing through the economy”.

Market participants also seem to believe in this path for interest rates. The fed funds futures market implies the likelihood of a hike at the May FOMC meeting is 90%, but a further 25 basis point (0.25%) hike in June at around 25%. These probabilities are roughly in line with where they were at last night’s close, confirming that this PCE print largely met market expectations.


Today’s PCE data is largely what was expected, and the while inflation trend grinds on, we believe we will see a continued cooling throughout 2023 with inflation likely to be under 4% by the end of the year. There is still uncertainty out there however, and the U.S. economy is likely at an inflection point with consumer spending softening in recent months, as consumers have become more pessimistic about the future. The latest consumer confidence report corroborates that thesis. This weakening consumer data, combined with what we now know about PCE, puts the Fed in a position to potentially suspend the current rate hiking cycle after one more rate hike next week. The improved inflation dynamics, a slowdown in business activity and signs of a softer job market will likely force the Fed to consider ending its current rate hiking campaign later this year.



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