Latest PCE data supports a March 2024 rate cut, with 2% PCE inflation possible in 1Q24
As opposed to inflation lingering at elevated levels, it is increasingly dissipating, with signs growing that the US economy could venture into outright deflation.
Executive summary
The latest PCE inflation data revealed deepening disinflation, with headline PCE growth MoM negative for the first time since April 2020. Furthermore, MoM core PCE growth was just 0.06%, which is also the lowest rate of growth that has been seen since April 2020.
All key aggregate PCE measures (headline, core, supercore) are now recording growth of 2% or less on a 6-month annualised basis — the last time this occurred was September 2020.
Another month of material declines in gasoline prices in December, and a continuation of current 6-month average growth trends, suggests that the headline PCE Price Index could fall below the Fed’s 2% YoY target in February 2024.
A continuation of the current 6-month average MoM growth rate would see the core PCE Price Index fall to 2.0% in April 2024, and supercore PCE inflation fall below 2% in January 2024.
Given that current growth rates suggest that the Fed’s 2% inflation target will be hit in 1Q24, the latest PCE data supports current market expectations for a March 2024 rate cut.
MoM change: headline growth turns negative
For the first time since April 2020, the US PCE Price Index (PCEPI) recorded MoM deflation, falling by 0.07% in November.
The core PCE, which excludes the impact of another major decline in gasoline prices, rose by just 0.06%, which is also the lowest rate of growth that has been seen since April 2020.
Note that this includes the impact of lagging rental prices, which continue to put upward pressure on the PCEPI. Supercore PCE growth (which excludes housing from the core PCEPI) was also negative in November — -0.03%.
A key driver of the headline and supercore deflation in November were durable goods prices, which fell by 0.4%. Three of the four key subcomponents declined, with both the furnishings and durable household equipment, and recreational goods and vehicles categories, recording particularly large MoM declines of 1.2%.
The nondurable goods category saw an even larger MoM decline of 0.9%. In addition to another very large decline in the gasoline and other energy goods category (-5.6% MoM), the clothing and footwear category also saw a major price decline in November (-1.4% MoM).
Finally, services prices rose by 0.25% in November, up from 0.20% in October. The lagging housing component remained a key driver, with the housing and utilities subcomponent seeing MoM growth increase to 0.6%.
The transportation services component also saw very significant MoM growth, rising by 1.1%. This was driven by airline fares, which rose by 2.8% MoM.
PCE services excluding housing and energy saw MoM growth of just 0.12%, in-line with October’s increase. This marks the third time in the past four months that MoM growth has been 0.12% or less.
3-month annualised change: major disinflation continues to be evidenced
Turning now to price changes on a 3-month annualised basis, headline PCE growth has fallen to just 1.4%, down from 3.1% in October.
The less volatile core PCEPI has seen growth fall to 2.2%, down from 2.3% in October, while supercore PCE growth fell to 1.4%, down from 1.6% in October. This was the fifth consecutive month that supercore PCE growth has been below 2% on a 3-month annualised basis.
Clearly, high levels of inflation are no longer being seen, with growth instead returning to relatively normal levels.
The return to more moderate growth rates has been driven by both durable and nondurable goods, where significant deflation has been seen over the past three months.
Durable goods prices declined by 3.2% on a 3-month annualised basis in November, while nondurable goods prices declined by 3.4%. Given plunging gasoline prices (3-month annualised change: -27.7%), the decline in nondurable goods prices was foreshadowed in my prior PCE review, but the decline was also supported by falling apparel prices (3-month annualised change: -7.7%).
Services prices saw an increase in growth to 3.8% (from 3.4% in October), but price growth remained below 4% for the seventh consecutive month.
Services prices excluding energy and housing saw 3-month annualised growth of 2.9%, up from 2.7% in October — though for the third time in the past four months, growth remained below 3%, suggesting that even lagging services price growth has normalised to a significant extent.
6-month annualised change: all key aggregate PCE measures record growth of 2% or less
Looking at price trends on a slightly longer-term basis, durable goods price growth has fallen to -4.3% on a 6-month annualised basis. This is the largest decline that’s been seen since October 2003, with all four key subcomponents declining by at least 3.0%.
The nondurable goods category is still seeing growth on a 6-month annualised basis, but only a modest 1.2%. Given another large expected decline in gasoline prices in December, nondurable goods price growth is likely to fall further — and potentially turn negative.
Services price growth remained at 3.4%, with the transportation subcomponent now seeing the fastest growth, at 6.0% annualised. This is followed by the lagging housing and utilities subcomponent, which saw 6-month annualised growth of 5.7%.
Services excluding energy and housing saw 6-month annualised growth of 2.7%, down slightly from the 2.8% recorded in October. November 2020 was the last time that growth of 2.7% has been recorded.
Putting it all together, the headline PCEPI grew at a 6-month annualised pace of just 2.0% in November, down from 2.4% in October.
The core PCEPI grew at an even slower pace of 1.9%, down from 2.3% in October, while supercore PCE growth slowed to a crawl — just 1.1%, down from 1.6% in October.
This was the first time that all three of these aggregate PCE measures have recorded 6-month annualised growth at, or below the Fed’s 2% target, since September 2020.
YoY change: disinflation has flowed through significantly to annual measures
On an annual basis, headline PCE inflation fell to just 2.6% in November, down from 2.9% in October.
Core PCE growth declined to 3.2% (from 3.4% in October), while supercore PCE growth fell to just 2.4% (from 2.7% in October).
With headline and supercore growth having now almost decelerated to 2%, and the core PCEPI also moderating significantly, the major disinflation that has been seen on a monthly basis has now significantly worked its way through to YoY measures.
PCE outlook: 2% annual PCE target could be hit in 1Q24
With major disinflation having now occurred, it’s useful to look at just when the Fed’s 2% target may be achieved.
Over the past six months, monthly headline PCE growth has averaged 0.17%, core PCE growth has averaged 0.15% and supercore PCE growth has averaged 0.09%.
Assuming headline PCE growth of 0.05% in December (which is expected to be supported by another major decline in gasoline prices and compares to average growth of -0.02% over the past two months), and monthly growth of 0.17% thereafter, annual PCE growth would fall below 2% in February 2024.
Assuming that core PCE growth continues at a MoM rate of 0.15%, YoY growth would fall to 2.0% in April 2024.
Assuming that supercore PCE growth continues at 0.09%, annual price growth would fall below 2% in January 2024, and fall to just 1.1% by May 2024.
Implications for monetary policy & the economic outlook
With headline PCE growth of 2% YoY potentially just three more PCE reports away, Fed Chair Powell’s comments at the last FOMC press conference in regards to when the level of restriction on the economy should begin to be reduced — “you’d want to be reducing restriction on the economy well before 2% because -- or before you get to 2%, so you don’t overshoot” — suggests that the Fed needs to get a move on with loosening monetary policy.
While another month of PCE growth that is in-line with recent trends would support a January rate cut, the Fed is unlikely to make such a move without clearly orchestrating it beforehand. With markets currently pricing in a high likelihood of a March rate cut (as at the time of writing, the CME FedWatch Tool is reporting a 91% probability of the federal funds rate being below its current level after the March FOMC meeting), the Fed may instead use its January meeting to signal a more imminent move to rate cuts.
As outlined above, should recent trends continue, annual headline/core/supercore PCE growth would be 2.1%/2.5%/1.8% at the time of the Fed’s March meeting (PCE data for February will not have been released by the time of the Fed’s March meeting). Given that the Fed’s inflation target would practically be already achieved at this point, and that Fed Chair Powell has stated that “you’d want to be reducing restriction on the economy well before 2% because -- or before you get to 2%, so you don’t overshoot”, a data-dependent approach should result in a March rate cut, but the Fed may yet still push an initial rate cut further into 2024 (a potential reason given for such a move could be relatively higher CPI growth, which is in part simply driven by a higher weighting to lagging rent based measures).
In terms of the broader inflation outlook, with changes in the M2 money supply impacting prices with a lag, it’s well and truly past time to erase concerns about the prospect of lingering high inflation, and the potential for an imminent 1970s style “second” wave of inflation.
Instead, with monetary policy remaining restrictive and the M2 money supply continuing to record YoY declines (note that changes in the M2 money supply impact prices with a lag) whilst 6-month annualised PCE growth has already returned to the Fed’s 2% target, the risk of the US economy venturing into outright deflation is becoming more prominent.
Should MoM inflation revert towards a trend of outright deflation in 2H24 or 2025, this would significantly increase the risk of a drastic policy reversal from the Fed in order to try and avoid a deflationary bust. Should such a reversal occur, and it lead to a drastic increase in the M2 money supply, then this is when concern will need to once again shift to the risk of another bout of high inflation — but such a state of play is far from the current case.
By continuing to read Economics Uncovered, you can rest assured that I will be keeping you up-to-date on where inflation is likely to head.
Merry Christmas and thank you for following my work at Economics Uncovered during 2023.
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Great insight as always thanks and happy new years 🎊