The Federal Reserve’s preferred inflation gauge edged higher in December 2023, although economists argue that the broader trends keep the door open for early cuts to interest rates.
Last month, the annual Personal Consumption Expenditures (PCE) price index was unchanged on an annual basis from November 2023 at 2.6 percent, but rose by 0.2 percent on a monthly basis, according to the Bureau of Economic Analysis (BEA).
Core PCE, which strips out the volatile energy and food components, eased to 2.9 percent from a year ago and increased by 0.2 percent from November 2023 to December 2023.
Monetary authorities apply more weight to the PCE than the Consumer Price Index because the former maintains a wider range of goods and services and regularly modifies weightings to reflect adjustments in consumer spending trends.
Despite the year-end uptick, overall inflation in the final three months of 2023 slowed to an annualized rate of 1.7 percent. The White House touted the latest inflation numbers.
“That’s an important milestone that means more breathing room for working families,“ President Joe Biden said in a statement. ”This means significant progress for American workers—with wages, wealth, and employment all higher than they were four years ago.”
Bureau of Labor Statistics (BLS) data show that hourly wage growth is down by 2.6 percent since February 2021, and real median weekly earnings are down by more than 5 percent since the all-time high recorded in October 2020.
The three- and six-month annualized inflation measurements are below the central bank’s 2 percent target rate.
“The good news is we are on course to see 2 percent inflation, possibly lower, over the course of 2024,” Howard Ward, chief investment officer of growth equities at Gabelli Funds, said in an analyst note.
The public has turned optimistic that inflation will continue to ease.
Interest Rates and the Economy
The treasure trove of positive economic indicators has led many observers to champion the case for the policymaking Federal Open Market Committee (FOMC) to begin cutting interest rates this year.
However, the thinking on Wall Street is that solid economic figures suggest that the Fed has been afforded more room to keep rates higher for longer until policymakers are confident that inflation has returned to the sustainable 2 percent pace.
In the fourth quarter, the gross domestic product growth (GDP) rate was 3.3 percent, topping the consensus estimate of 2 percent. In 2023, the overall economy expanded 2.5 percent, up from 1.9 percent in 2022. In addition to the better-than-expected gross domestic product, the U.S. labor market is forecast to create 178,000 new jobs to kick off the year.
All of the latest developments have prompted investors to shift their policy rate expectations.
According to the CME FedWatch Tool, the futures market has postponed its rate cut projections to May. In recent months, traders had been betting that the Fed would reduce the benchmark rate as early as March.
The Fed’s Summary of Economic Projections (SEP) signaled three rate cuts in 2024 and two more in 2025.
“Investors continue to debate the economy’s path of least resistance as we move into late January. It seems like many market pundits, if not most, are in the soft-landing camp, seduced perhaps by the hypnotic powers of last year’s rising stock market, especially the fourth-quarter rate relief rally,” Mr. Ward said.
Recession odds have diminished, with slower growth being the base case for market observers.
SEP data suggest that real GDP growth this year would be 1.4 percent. JPMorgan Chase economists anticipate below-trend growth of 0.7 percent. The Conference Board projects back-to-back negative GDP growth in the second and third quarters “that will be broadly felt across the economy.”
Mr. Ward thinks the probabilities of a recession are much higher than many believe, and this could help justify why investors have priced in a half-dozen rate cuts in 2024.
“With the yield curve inverted and both the purchasing managers’ indices and the Index of Leading Economic Indicators in a prolonged slump, the likelihood of recession is probably 70 percent or higher,” he said. “That is why the fed funds futures market is pricing in six rate cuts this year, totaling 150 basis points.”
The two- and 10-year yield inversion is negative 14 basis points, while the Fed’s preferred three-month and 10-year yield is negative 130 basis points.
Market analysts pay close attention to this development because when long-term bond yields are below short-term Treasurys, it signals a recession. This metric has also had a solid track record of prognosticating a downturn.
The Conference Board’s Leading Economic Index (LEI) has been in contraction territory for 21 straight months, dropping by 0.1 percent in December 2023. The LEI is one of the chief recession indicators.
For Fed Chair Jerome Powell and the rate-setting FOMC members, below-trend growth is a necessity to bring inflation back down to target.
“The record suggests that a sustainable return to our 2 percent inflation goal is likely to require a period of below-trend growth and some further softening in labor market conditions,” Mr. Powell told reporters after the FOMC meeting in October 2023.
Whether the economy accelerates or decelerates in the year ahead, economists contend that it will depend on the consumer. Despite an environment of high inflation and soaring borrowing costs, consumers have propped up the economic landscape thanks to a blend of exhausting pandemic-era savings, increasing credit card debt to a record high, and a tight labor market.
In December 2023, while personal income jumped by 0.3 percent, personal spending surged by a higher-than-expected 0.7 percent. The personal saving rate—personal saving as a percentage of disposable personal income—dipped to 3.7 percent.
The next two-day FOMC policy meeting will take place on Jan. 30 to Jan. 31.
