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The Fed's "favorite" inflation indicator was released on Friday. Will it support a sharp interest rate cut this year?
The core PCE price index, the Fed's favorite inflation indicator, will be released on Friday night, and this data will provide further key clues for the Fed to cut interest rates.
It is widely expected that the PCE price index in the United States will fall back to 2.3% in August, the lowest level since the beginning of 2021, but the core PCE price index will increase by 0.1% to 2.7% compared with July. Economists believe that the rise in core inflation stems from the unexpected rise in housing costs, but the current rent and housing prices tend to be stable, and inflation in major areas except housing has eased. Therefore, the inflation index in August may support the Fed to cut interest rates further.
On the other hand, investors are quietly preparing for the return of inflation, thinking that the road to "fighting inflation" has a long way to go. The data shows that investors' average inflation expectation for the next five years is 2.04%, which is higher than 1.86% at the beginning of the month. The loose pace of the Fed's interest rate cut by 50 basis points a few days ago may rekindle the inflation risk in the second half of the year.
According to the latest survey by Bloomberg:
In August, the PCE price index of the United States is expected to increase by 2.3% year-on-year, or it will hit the lowest level since the beginning of 2021, down by 0.2 percentage points from the previous value of 2.5%, and the month-on-month increase is expected to drop from 0.2% in July to 0.1%.
The core PCE price index is expected to increase by 2.7% year-on-year, 0.1 percentage point higher than the previous value of 2.6%, and the chain-on-chain increase is expected to remain unchanged at 0.2%.
Housing cost "exaggerates" inflation? August data may support further interest rate cuts.
The market expects the US PCE price index to fall back to 2.3% in August, hitting the lowest level since the beginning of 2021. Some economists even predict that the Fed will achieve its 2% inflation target in January or February next year. Gregory Daco, chief economist of Parthenon-Ernst & Young, said:
We expect PCE to be around 2.5% by the end of the year, and then close to the Fed's 2% target in early 2025.
On the other hand, however, the market expects core inflation to rise in August: the core PCE price index is expected to rise from 2.6% to 2.7% in August. In this regard, some economists explained that the most likely reason for the rising source of inflation was the unexpected sharp increase in housing costs last month. However, recent trends show that rents and house prices have stabilized, and inflation may slow down further in the coming months.
Some senior Fed officials, including Federal Reserve Chairman Powell, believe that the housing index exaggerates the inflation rate in the United States. And housing is the largest component of the main inflation index of the US government.
According to the analysis, inflation has eased in most areas except housing. The upcoming PCE inflation indicator data may show that inflation has cooled down and support the Fed to cut interest rates further. As long as rents continue to fall, Fed officials are prepared to ignore the expensive housing costs to better understand the potential inflation rate.
Nationwide economists wrote in a report:
Although there may be some bumps along the way, at present, inflation seems to be moving towards the Fed's 2% target.
However, investors are quietly preparing for the return of inflation.
The current market worries about the resurgence of inflation have not been eliminated.
As of Tuesday, both inflation swaps and Treasury inflation-protected securities indicated that inflation may hover above the Fed's 2% target in the next few years. According to the latest data from the St. Louis Federal Reserve, the five-year break-even inflation rate in the United States (reflecting investors' expectations for the average inflation rate in the next five years) recently climbed to 2.04%, and earlier this month, this indicator hit a nearly four-year low of 1.86%.
The inflation swap market has also shown a similar trend. According to Tradeweb data, as of Tuesday, the inflation rate of one-year swaps linked to the overall CPI was 2.028%, while that of five-year swaps was 2.333%, both of which were higher than the lows in September.
The Federal Reserve lowered its policy interest rate target by 50 basis points last week, further relaxing monetary policy. Tim Murray, a capital market strategist at T. Rowe Price, said that inflation may reignite in the second half of this year:
They prefer to gradually reduce inflation to avoid economic recession, but this road means that inflation risks still exist. Not only will inflation take longer to subside, but it may be rekindled with the arrival of the second half of the year.
Even some senior Fed officials are worried that inflation has not been completely defeated. Bowman, the only Fed governor who voted against it last week, pointed out in a statement that such a dramatic first rate cut may unnecessarily restore inflationary pressure.
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