The Federal Reserve’s favorite inflation gauge, the personal consumption expenditures (PCE) price index, came in better than expected last Friday. What does this mean for the Fed’s path forward?
Well, it’s a positive sign the Fed will stay the course for its remaining rate hikes this year. Indeed, the December PCE showed a 5% price increase from the same month last year, while increasing 0.3% month-over-month. This is a notable deceleration from the 5.5% and 6.1% inflation found in the November and October PCE reports, respectively.
Core PCE, which excludes the volatile food and energy categories, increased by 4.4%. Not only is this another decrease from November’s 4.7% annual rate, it’s the lowest change since October 2021.
While 5% inflation is still a ways away from the Fed’s long-stated 2% goal, the report is a win by most accounts. Especially compared to June’s 40-year high at 7%, it’s hard not to blush at the promising inflation improvement.
Despite this, not everything was sunny side up on Friday. The Commerce Department reported overall consumption expenditures fell 0.2% in December, making it the second straight month of declining spending. While the Fed’s interest rate hikes have forced inflation to retreat, it’s clear consumers are also starting to feel the impact of the tightening. Unfortunately this may well be the beginning of a recession, especially given the Fed’s current trajectory.
“Real consumer spending fell for two consecutive months at year-end, another sign the economy may have already entered a recession,” said Bill Adams, Chief Economist at Comerica Bank.
PCE Price Index Falls Ahead of FOMC Meeting
Friday’s PCE report comes as something of a prologue to the Fed’s Federal Open Market Committee meeting (FOMC) this week. Indeed, the central bank is expected to hike rates yet again, this time by 25 basis points. However, this week’s hike is expected to be the second-to-last or final rate increase for the foreseeable future. Most economists agree the Fed has likely tightened enough; the only thing left to do is wait.
In that regard, the PCE may be a promising signal the Fed will follow through with its current schedule. According to Jeffrey Roach, Chief Economist at LPL Financial, the Fed could even take it a step further. “The Fed can legitimately downshift the pace of rate hikes next week as inflation cools,” he said.
Others believe the Fed’s best path forward has long been decided. This includes Sumit Handa, Managing Director for Pennington Partners. Handa informed InvestorPlace ahead of the PCE that the Fed’s eventual rate hike pause is already a near-certainty:
“Regardless of what the personal consumption expenditure (PCE) numbers look like in Friday’s report, we believe the Fed is close to ending rate hikes. 2022 was one of the worst years for stock market performance since 2008, while the global government bond index fell 17.1% – the worst performance since 1788 when George Washington became president. There are a confluence of economic factors that will eventually lead to the Fed pausing on rate hikes. We believe inflation – for this cycle – has peaked, and will eventually lead to deflation.”
On the date of publication, Shrey Dua did not hold (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
