Economic releases containing inflation numbers have been a gut-wrenching roller coaster ride for the markets. However, an eagerly awaited inflation report next Friday could prompt a Fed pivot and finally set the Fed’s policy direction. This would resolve a problem because, over the past couple of years, the U.S. Federal Reserve has been laser-focused on taming inflation. Yet, despite a record-setting tightening regimen in 2022, the pace of consumer price increases has remained persistently high. The Fed is now at a crossroads. If the next report or two show rising inflation, the Fed may continue tightening its monetary policy. Conversely, if the reports show reduced inflation, the Fed may proceed with plans to lower interest rates.
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That’s why this Friday’s release of the Personal Consumption Expenditures (PCE) Price Index is circled in red on every economist’s calendar. It could be the trigger that sets the Fed’s direction. Any true pivot from the Fed could then send markets bolting in one direction or another.
Wall Street Holds its Breath
All markets can be impacted by U.S. inflation, so there’s a crowd on Wall Street holding their breath, waiting for low PCE data. They might get their wish because most economists are predicting a slight dip in inflation compared to March’s numbers. However, if the report misses expectations, it could get ugly. Even a small increase could reignite fears of persistent inflation and prompt a more aggressive response from the Fed. Conversely, a significant decrease in inflation could signal room for the Fed to ease off the brakes.
PCE Data is the Fed’s Fave
The PCE Price Index data is the most important of all the inflation reports because the Fed prefers this measurement. It gauges changes in the prices of goods and services that consumers purchase, even if they substitute cheaper products. According to the Fed, the way PCE is measured more accurately reflects inflation’s impact on household budgets compared to the more commonly discussed Consumer Price Index (CPI).
While the overall or headline PCE number is important, the core PCE, which excludes volatile food and energy prices, is the one the Fed watches most closely. This is because core inflation provides a clearer picture of underlying inflationary trends.
According to a survey of economists conducted by the Wall Street Journal, the PCE price data is expected to show a small improvement compared to the first quarter. Core inflation is expected to rise by 0.2%, slightly better than the 0.3% rate seen in March. This would make it the lowest reading this year.
The Fed’s Tightrope Walk
The Fed is in a precarious position. They need to combat inflation without derailing economic growth. A dovish pivot too early, if inflation remains stubbornly high, could lead to a resurgence of price pressures. On the flip side, an overly hawkish stance could stifle economic activity and potentially trigger a recession.
Friday’s PCE Data Could Be a Pivotal Print
When the PCE data is released on Friday, a surprise on the low side could take any talk of rate hikes off the table completely and open up the conversation for easing expectations. This scenario would likely be welcomed by equity markets. However, if inflation remains uncomfortably high, the Fed might embark on a more aggressive tightening path, potentially dampening market sentiment.
Key Takeaway
Friday’s PCE release is a high-stakes event for the Fed and financial markets alike. The data will provide crucial clues about the trajectory of inflation and, consequently, the Fed’s monetary policy decisions. A surprise low number could buoy markets, while a higher-than-expected reading might trigger a sell-off. As the last day in May, Friday has the potential to set the market’s tone through the summer.
