Pro Perspectives 12/22/23






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December 22, 2023

November core PCE was reported this morning.  This is the Fed’s favored inflation gauge.

As we’ve discussed over the past week, not only has inflation continued to go the Fed’s way (lower, toward its goal of 2%) but it’s accelerating lower.

Remember, Jerome Powell told us last week that they expected this November number (core PCE) to be 3.1% — the lowest since March of 2021.

In my last note, we looked at the index data heading into this report.  If we extrapolate out a 3.1% number, that means the inflation for November would have to go (slightly) negative (i.e. indicating deflation in November).

And as we discussed, we did already see deflationary price data in the eurozone and the UK last month.

So, what were the numbers?  This morning’s report on U.S. core PCE came in at 3.2% year-over-year, on a 0.1% rise in prices in November.

But guess what?  Had the government not revised DOWN the last four consecutive months of core PCE index data, the November monthly prices would have indeed fallen (i.e. deflation).

Bottom line:  With the Fed holding rates above 5% as inflation is closer to 3%, they are putting more and more downward pressure on the economy AND inflation.

On the latter, the Fed has already told us that they will have to start cutting rates “well before two percent” (the Fed’s 2% inflation target).  Why?  As Powell has said, if they wait for two percent, “it would be too late.”  They would overshoot to the downside.  And an overshoot to the downside means the Fed would risk inducing a deflationary spiral.

And as we’ve discussed often in my daily notes, a deflationary bust (low or contracting economic activity and falling prices) is far worse than inflation.  Deflation can be impossible to escape.

So, with the accelerating fall in inflation (which includes the government’s downward revisions on the past four months), the Fed will have to be aggressively cutting rates next year — and soon.  In fact, bets are now being placed for as early as January.

The next core PCE data will be reported on January 26.  The Fed meets on January 31.  The market is pricing in a 16% chance of a January cut, and now a near certainty of a March cut.  The Fed has projected June.

How “overly tight” is the Fed, at this point?  As the chart below shows, they are almost 170 basis points above where they want to be when inflation is at their target of 2% (the red line).

All of this said, despite the Fed’s throttling of the economy, the Atlanta Fed GDP model shows the economy is still running at a solid 2.3% annual rate.

Add in some rate cuts, a weaker dollar (which can absorb disinflationary pressures), and the deployment of fiscal packages (e.g. Chips Act) — and we could have a very good economy in 2024 with above average growth, stable 2% to 3% inflation, a tight labor market, and strong wage gains driven by the ongoing productivity boom.

The ingredients are there.

This will likely be my last Pro Perspectives note this year.  I want to extend my best wishes to you and your family for a Merry Christmas and a Happy and Healthy New Year!

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