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PCE Release Indicates Slowing Progress on Inflation, Rate Cut Expectations Are Pushed Out

Yesterday’s release of the January Core PCE Index (the Fed’s preferred inflation gauge), showed a monthly increase of 0.4%. This comes on the heels of December’s 0.1% core reading. The recent trend of “bifurcated” supply/demand metrics continues. Goods prices were lower by 0.2% while services were up 0.6%. This closes out the January data releases. The big questions: will disinflation take hold in 2024, spurring the Fed to cut rates? Were January numbers skewed slightly higher due to year end/seasonality factors? The next two months of releases of the February/March data will be closely watched, starting with next Friday’s jobs report. Note that the Cleveland Fed’s “Inflation Nowcasting” site shows predictions of February core PCE of 0.23% and March 0.22%.

Expectations were put on hold the last month. Thirty days ago, the Fed futures market indicated a 94% chance of a rate cut at the May meeting. Today those chances are at 25%. The 10-year Treasury spiked from 3.87% to 4.25% in those 30 days. Note, however it’s rallying today down to 4.20% on manufacturing data. Purchase Managers Index is indicating contraction for the 16th straight month. Best case scenario (aka today’s dialed back expectations) seems to be 3 (or 4) rate cuts this year starting in June. Multiple Fed officials have recently said “in the summertime” to telegraph a June start at the earliest. We may see more “telegraphing” by Fed officials as any moves during the heat of the 2024 election campaign are by definition, controversial.

Treasury supply issues were in focus this week as the biggest 5 year note auction ever ($64 billion of new issues) saw “tepid” demand. Rising budget deficits and slow inflation progress spurred bond giant PIMCO to predict that “term premiums” in long term treasury bonds (5, 10 and 30 years) may come back to levels seen in the late 1990s and early 2000s (the term premium is presently negative). This is a reminder that fixed rates (treasuries) may fluctuate independently from floating rates (Fed Funds, SOFR, Prime). Stay tuned…

By David R. Pascale, Jr., Senior Vice President at George Smith Partners.