The Fed’s favored gauge of inflation is core PCE (personal consumption expenditures). It measures the change in prices of goods and services that people have actually paid — not just a selling price. “Core,” means excluding food and energy prices.
The December report on core PCE came in this morning.
With the Fed meeting next Wednesday, how might this most important data point guide them on next moves?
The answer: It should give them justification to pause on the tightening cycle.
As we’ve discussed often here in my daily notes, the inflation storms of the past have only been quelled when interest rates are taken ABOVE the rate of inflation.
In this case, the Fed has used a combination of tools to manufacture the desired outcome. They’ve used a combination of rates, quantitative tightening AND a copious amount of talking (talking markets down, talking demand down).
With that mix, the Fed managed to stop the rise in core PCE early last year, and reverse it, without having to take rates to the double-digit levels of the early 80s.
So, we now have the latest year-over-year change in core PCE at just 4.4%!
As you can see in the chart below, assuming the Fed goes through with another quarter point hike next Wednesday, we will have interest rates (the effective Fed funds rate) ABOVE the rate of inflation (core PCE).
This should give the Fed plenty of justification to hit the pause button, as the Bank of Canada has just done.