The Federal Reserve's favorite inflation indicator - the Core PCE Price Index - is set to be released this Friday evening. This data will provide further key clues for the Federal Reserve to cut interest rates.
The market generally expects that the increase in the US PCE Price Index in August will fall back to 2.3%, the lowest level since the beginning of 2021. However, the Core PCE Price Index is expected to rise by 0.1% from July to 2.7%. Economists believe that the rise in core inflation is due to the unexpected increase in housing costs, but the current rent and housing prices are trending towards stability, and inflation in the main areas other than housing has eased. Therefore, the inflation indicators in August may support the Federal Reserve to further cut interest rates.
On the other hand, investors are quietly preparing for the return of inflation, believing that the road to "fighting inflation" is a long one. Data shows that investors' expectations for the average inflation over the next five years are 2.04%, higher than the 1.86% at the beginning of the month. The Federal Reserve's recent easing pace of cutting interest rates by 50 basis points may reignite inflation risks in the second half of the year.
According to the latest Bloomberg survey:
The US PCE Price Index in August is expected to rise by 2.3% year-on-year, touching the lowest level since the beginning of 2021, falling by 0.2 percentage points from the previous value of 2.5%, and the month-on-month increase is expected to fall from 0.2% in July to 0.1%.
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The Core PCE Price Index is expected to rise by 2.7% year-on-year, up by 0.1 percentage points from the previous value of 2.6%, and the month-on-month increase is expected to remain unchanged at the level of 0.2%.
Does housing cost "exaggerate" inflation? August data may support further interest rate cuts.
The market expects the US PCE Price Index in August to fall back to 2.3%, touching the lowest level since the beginning of 2021. Some economists even predict that the Federal Reserve will achieve its 2% inflation target in January or February next year. Gregory Daco, Chief Economist at PwC-EY, said:We anticipate that the PCE will be around 2.5% by the end of the year, and then approach the Federal Reserve's 2% target in early 2025. On the other hand, 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 this regard, some economists explain that the most likely reason for the rise in inflation is the unexpectedly sharp increase in housing costs last month. However, recent trends indicate that rents and housing prices have stabilized, and inflation may further slow down in the coming months.
Some senior officials of the Federal Reserve, including Chairman Powell, believe that the housing index overstates the inflation rate in the United States. Housing is the largest component in the main inflation index of the U.S. government.
Analysis suggests that inflation has eased in most areas except housing. The upcoming PCE inflation indicator data may show a cooling of inflation and support further interest rate cuts by the Federal Reserve. As long as rents continue to decline, Federal Reserve officials are ready to ignore the expensive housing costs to better understand the underlying inflation rate.
Economists at Nationwide wrote in a report:
Despite some bumps along the way, inflation seems to be heading towards the Federal Reserve's 2% target at present.
However, investors are quietly preparing for the return of inflation.
The current market's concern about the resurgence of inflation has not been eliminated.As of Tuesday, inflation swaps and U.S. Treasury Inflation-Protected Securities both suggest that inflation may hover above the Federal Reserve's 2% target in the coming years. According to the latest data from the Federal Reserve Bank of St. Louis, the U.S. five-year breakeven inflation rate, which reflects investors' expectations for the average inflation rate over the next five years, recently climbed to 2.04%, having touched a nearly four-year low of 1.86% earlier this month.
The inflation swap market also shows a similar trend. Tradeweb data indicates that as of Tuesday, the one-year swap inflation rate linked to the overall CPI is 2.028%, while the five-year swap is at 2.333%, both of which have risen from their lows in September.
The Federal Reserve has further eased monetary policy by lowering the policy interest rate target by 50 basis points last week. Tim Murray, a capital markets strategist at T. Rowe Price, stated that inflation may reignite in the second half of this year:
They would prefer to gradually reduce inflation to avoid a recession, but this path implies that inflation risks still exist. Inflation not only takes longer to subside, but it may also be reignited as the second half of the year approaches.
Even some senior Federal Reserve officials are concerned that inflation has not yet been completely defeated. Bowman, the only Federal Reserve governor who voted against the decision last week, pointed out in a statement that such a dramatic first interest rate cut could unnecessarily revive inflationary pressures.