US PCE data opens the door a little further for the FED to begin cutting rates

The US PCE deflator reading for October has further cemented expectations that the Fed will finally be able to call an end to the current interest rate tightening cycle and prepare the way for interest rate cuts to be delivered in H1 2024. The monthly headline reading was flat on the month, allowing the annual rate to fall from 3.4% to 3.0%. But more crucially from the perspective of the Fed, the core monthly rate rose by just 0.16%, pushing the annual core rate down from 3.7% to 3.5%. This is now the ninth month in succession that the annual rate has fallen, and given that it was running at 4.8% in June, the speed with which it has fallen since then has been fast. On a quarterly basis to October, the annualised core headline rate has now risen by just 2.2%, although the Fed will likely be looking for a sub-2% reading before being finally convinced that this latest inflation battle has been won.

Within the numbers, core goods prices were unchanged on the month, but the downwards trend remains in place, the annual rate of increase now only 0.3% compared to the 4.6% reading seen this time last year. This leaves the main upwards driver of pricing pressures stemming from the services sector; but here too the news is looking brighter. Core services prices ex-housing rose by just 0.15% on the month, bring the yearly annual rise down to 3.9%, the lowest reading since end Q1 2021. The key determinant of how fast core services prices will fall going forward will be very much determined by the pace of wages growth, given that wages typically represent around some 80% of service companies costs. But with wages growth now slowing and the normalisation of the quits rate pointing to an Employment Cost Index reading of around 3.5% by Q2 2024, the current pace of services inflation looks set to moderate going forward.

Putting all of this together, the picture being painted is that inflationary pressures are dissipating more rapidly than the Fed anticipated, and with all the evidence suggesting this fast pace of retraction will continue going forward. At the December FOMC meeting Powell is likely to stick to the mantra that the hawkish bias remains in place and that a further interest rate rise remains on the table. However, economic developments are making this line increasingly unsustainable. Indeed, the market has very much already moved on from the hawkish phase of the current cycle and looking towards the start of monetary easing. As such, it will not be paying any attention to Powell if he does repeat this message as expected.

Going forward, we continue to see all the pieces of the jigsaw puzzle in place for the Fed to begin cutting interest rates next year, possibly starting as soon as March, but with one cut at least being seen by the 31 March/1 April FOMC meeting.