Last week, we mentioned the Federal Reserve was eagerly awaiting the release of the December personal consumption expenditures (PCE) data. On Friday morning, the data release from the Bureau of Economic Analysis brought fresh information on the inflation condition in the United States.
Before we attack the details of the inflation report, we want to make sure it is clear why these metrics are essential. The Federal Reserve has two mandates at its most basic level: maximum employment and stable prices. With unemployment near all-time lows and the recent bout of explosive inflation, the Fed is laser-focused on the latter. So, the sooner they are comfortable that inflation has stabilized, the sooner rate cuts may begin. And the sooner rate cuts start, the better the conditions are for economic growth.
So, where does the Fed’s preferred inflation gauge stand as of the end of last year? Year-over-year, total PCE ended 2023 at 2.6%, while Core PCE (which excludes Food and Energy) was 2.9%. But is that good or bad? For comparison, these metrics averaged 1.7% from 2017-2019. On its face, that doesn’t sound great. And this could be the reason many economists are saying inflation is stubbornly high and the “last mile” is always the hardest.
However, if you slice the data differently, there are some very positive signs. Looking at shorter-term inflation changes can give us a better view of current inflation. So, instead of measuring inflation year-over-year, you can use annualized numbers for three or six-month changes. Core PCE is at 1.5% or 1.9%, respectively, using these measures. And when these numbers are viewed in comparison to the 2017-2019 period, they show inflation has returned to pre-pandemic levels. Additionally, this suggests that the “last mile” might already have been traveled.
Of course, it can be dangerous to cherry-pick data. But I would argue this is not cherry-picking, as these numbers don’t exclude any inflation components. They’re still measuring all the same data points, just on a shorter-term basis. And since many measures of inflation are slow to move, it would be easy to make the case it actually provides a better idea of where we currently sit.
As the Fed continues to watch inflation, these measures point to further declines in the year-over-year metrics. If that comes to fruition, it would be hard to envision a scenario where the Fed doesn’t cut rates at least a few times later this year.
Economy
- Markets were higher again this week, with the S&P 500 up 1.1%, the Nasdaq up 0.9%, and the small-cap Russell 2000 up 1.7%.
- According to the advance estimate, the U.S. economy expanded an annualized 3.3% in Q4 2023, much better than forecasts of a 2% rise and following a 4.9% rate in Q3.
- GDP Price Deflator in the U.S. increased an annualized 1.5% in the last quarter of 2023, compared to market forecasts of a 2.3% rise.
- Americans filing for unemployment benefits rose by 25K to 214K the week ending January 20, rebounding significantly from the 16-month low in the prior week and overshooting market expectations of 200K. In the meantime, continuing claims rose by 27K to 1,833K, slightly ahead of market expectations of 1,828K.
Stocks
- U.S. equities were in positive territory. Energy and Communication Services were the top performers, while Consumer Discretionary and Real Estate lagged. Value stocks led growth stocks, and small caps beat large caps.
- International equities closed higher for the week. Developed markets fared better than emerging markets.
Bonds
- The 10-year Treasury bond yield increased one basis point to 4.16% during the week.
- Global bond markets were in positive territory this week.
- High-yield bonds led for the week, followed by corporate bonds and government bonds.
