The Fed’s Preferred Inflation Gauge Hits Lowest Level in Three Years

Personal Consumption Expenditures Index Shows Decline

The Fed’s preferred inflation gauge, the Personal Consumption Expenditures (PCE) index, reported a slight decline in January, aligning with Wall Street’s expectations. Notably, this decline resulted in the PCE index reaching its lowest level in three years, a significant development in the ongoing inflation narrative.

In January, the PCE index grew by 2.4% year-over-year, showing a decrease from last month’s 2.6% print.^[1] Meanwhile, the core PCE, which excludes the volatile food and energy categories, came in at 2.8%, in line with economists’ expectations and a slight decrease from the month before.^[1]

Implications for Fed Policy and Investor Sentiment

The Federal Reserve closely monitors the core PCE as a key inflation measure, and its decline may influence forthcoming policy decisions by Fed Chair Jerome Powell and the Federal Open Market Committee. The report also comes on the heels of another inflation indicator, the Consumer Price Index (CPI), which recently surprised with faster price growth in January, leading to speculations and a subsequent shift in investors’ expectations regarding future interest rate cuts.^[2]

Previously touted as the benchmark representative of the Federal Reserve’s thinking amidst benign inflation, stock markets reacted to the hotter-than-expected CPI report and revised their projected interest rate cuts for 2024. The shift in sentiment, as indicated in Bloomberg data, now predicts three rate reductions instead of the former consensus of six cuts seen back in December. Prior to the release of the CPI report, investors had estimated a 58% likelihood of the first cut occurring in June. However, the report’s impact has caused markets to realign their estimates for a gradual decrease in the federal funds rate.^[2]

The Federal Reserve’s Approach to Inflation Challenges

The release of the minutes from the Federal Reserve’s January meeting provided insights into the officials’ concerns regarding adjusting interest rates promptly. Most officials expressed a desire to move cautiously, highlighting the risks of reducing rates too rapidly.^[4] Throughout recent commentary, Federal Reserve officials have consistently emphasized their desire for greater confidence in the reduction of inflation rates, reiterating their patience and determination in achieving inflation targets.^[5]

Impact on Market Outlook

The intricacies of inflation dynamics have a significant impact on the stock market, with interest rate expectations influencing investors’ behavior and market sentiment. While the PCE index’s decline indicates some relief to inflationary pressures, the unexpected CPI uptick, leading to reassessments in interest rate projections, introduces renewed uncertainties for the investment community.

Maintaining a data-dependent approach, Federal Reserve Chair Jerome Powell conveyed in a recent press conference on January 31, 2024, that an interest rate cut in March is unlikely, emphasizing the Federal Reserve’s deliberate and cautious consideration of the necessary data. Powell’s statement indicates that the committee requires a higher level of confidence to identify a suitable timing for rate adjustments.^[7]

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