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The Federal Reserve’s primary inflation rate, the core PCE price index, showed that core price pressures continued to cool more than expected in November. Core inflation has run at just a 1.9% annualized rate over the past six months, Commerce Department data show. S&P 500 futures pointed higher.
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The fall in inflation to the Fed’s 2% target on an annualized basis while unemployment remains below 4% and economic growth has been solid helps explain why policymakers are beginning to worry less about an inflation resurgence.
November PCE Inflation Rate
The personal consumption expenditures, or PCE, price index fell 0.1% in November, matching forecasts. The annual headline inflation rate fell to 2.6%, below 2.9% estimates that came before downward revisions to prior inflation data.
Typically, Federal Reserve decision-making puts more weight on core inflation, which strips out volatile food and energy prices. The core PCE price index rose 0.1% in November — actually 0.06% unrounded — cooler than 0.2% forecasts.
The core 12-month inflation rate eased to 3.2%, below Wall Street expectations of 3.4%.
Federal Reserve chair Jerome Powell has said policymakers wanted to see six months of tame inflation data to be sure that the disinflationary trend isn’t fleeting. On a six-month basis, PCE inflation is running at a 2% annualized rate, while core PCE inflation has fallen just below the Fed’s 2% inflation target.
Fed Rate Cut Odds Grow
After the November PCE report, market pricing showed 86% odds that the first rate cut will come at the March 20 meeting, up from 79% on Wednesday. Markets now see 48% odds of 1.75 percentage points in rate cuts next year, up from 38% before revisions to prior inflation data were published on Thursday with the latest estimate of Q3 GDP growth.
While the Fed penciled in 75 basis points in rate cuts for 2024 in its latest projections, markets have been pricing in twice as much, and they’re getting closer to pricing in another quarter-point reduction.
The rapid ebbing of inflation is making the current 5.25% to 5.5% range of the federal funds rate look increasingly restrictive.
The degree of Fed monetary policy tightness reflects the real federal funds rate, meaning how much its key interest rate exceeds the inflation rate. In Q3, the real federal funds rate was between 3.25% and 3.5%. That compares to the Fed’s long-term estimate of the neutral policy rate as 0.5% above its 2% inflation target. The neutral rate is one that neither restricts growth nor boosts it.
Supercore Inflation
Starting late in 2022, Federal Reserve chair Powell shifted the inflation focus to core PCE services excluding housing, or supercore services. That was in keeping with the Fed’s view that the tight labor market and elevated wage growth had been at the root of stubbornly high inflation. Wages make up a high percentage of costs for service businesses. Therefore, supercore services inflation should ease as wage pressures moderate.
Prices for these core nonhousing services, including health care, haircuts and hospitality, rose just 0.12% for a second straight month in November. The 12-month supercore services inflation rate eased to 3.5% from 3.8% in October and 4.1% in September.
That should reinforce that the disinflationary trend is broad-based, giving assurance to the Fed that a snapback in price pressures is unlikely.
Personal Income, Spending
The PCE price index is released with the Commerce Department’s monthly personal income and outlays report. Personal income rose 0.4% on the month, in line with forecasts. Personal consumption expenditures rose 0.2% in November, shy of forecasts for a moderate 0.3% rise.
S&P 500, 10-Year Treasury Yield
S&P 500 futures rose 0.3% after the inflation data in early Friday stock market action. The S&P 500 rose 1% on Thursday, bouncing back after Wednesday’s late-day 1.5% sell-off. That followed a 16% rally since Oct. 27, which lifted the S&P 500 within 1% of its Jan. 3, 2022, record close.
The S&P 500 rally has come amid a sharp drop in the 10-year Treasury yield, which is key not just for mortgage rates and auto loans, but for stock valuations. Analysts use the 10-year Treasury yield as the risk-free rate for discounting the present value of future earnings. As the 10-year yield falls, those future earnings streams for growth companies look more enticing.
On Friday, the 10-year Treasury yield dipped three basis points to 3.86%.
Be sure to read IBD’s The Big Picture column after each trading day to get the latest on the prevailing stock market trend and what it means for your trading decisions.
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