The Federal Reserve’s quest to return inflation to its 2% target took another hit this week. Inflation—as measured by the central bank’s favorite gauge, the core personal consumption expenditures (PCE) price index—jumped 0.4% last month, and 2.8% from a year ago, the Bureau of Economic Analysis reported Thursday.
The figures amounted to a blow for Fed officials who had been hoping to begin cutting interest rates with inflation steadily fading from its four-decade high in 2022 of 9.1%. While the core PCE price index was in line with Wall Street’s consensus forecast, economists warn the 2.8% figure just isn’t enough for Fed Chair Jerome Powell and company to feel comfortable cutting rates this spring. The core PCE price index measures the prices of goods and services, excluding food and energy, which are subject to wide price swings.
As David Alcaly, lead macroeconomic strategist at Lazard Asset Management, explained, the “hot” inflation data “adds to uncertainty and pushes back rate cut expectations.” Still, overall, Thursday’s inflation report was more of a “speed bump” in the Fed’s quest to tame inflation, according to Alcaly.
However, Citi economists, led by chief U.S. Economist Andrew Hollenhorst, warned that the odds of a recession have risen after the latest inflation report. Hollenhorst said that the Fed won’t be able to cut rates until June now and argued that there is “little prospect for disinflation” at the moment, given the strong labor market and resilient consumer.
“Growth is only gently slowing … meaning policy rates are likely to stay on hold,” he wrote, adding that ”higher inflation and higher policy rates today increase the probability of a recession later this year.”
On the other hand, Capital Economics’ chief North America economist, Paul Ashworth, echoed Alcaly’s view in a Thursday note to clients, labeling the “resurgence” in core inflation “a speed bump rather than pothole.” Ashworth argued that the latest inflation report will rule out an early interest rate cut from the Fed this year. Not long ago most market participants expected the first rate cut in March, but Ashworth noted that the lack of an early cut shouldn’t alter “the broader picture” moving forward.
“There is still plenty of disinflation coming this year, which means that the annual rate of core PCE inflation will be close to the 2% target by midyear,” he argued.
To his point, personal spending—which drives 70% of U.S. GDP growth, and by extension inflation—fell 0.1% in January, after surging 0.6% in December. A 1.1% decline in spending on goods drove the move. And although that decline in spending can be partly explained by bad weather last month, it’s likely a sign that consumers are pulling back on spending overall, which should help with inflation.
Backing that up, real disposable income, a measure of consumers’ income after expenses and adjusted for inflation, also fell 0.1% in January. “Investors should pay close attention to the slowdown in real disposable income as a potential sign that consumers are nearing the end of their spending splurge,” Jeffrey Roach, LPL Financial’s chief economist, said of the data.
For Roach, like most of his peers, the latest inflation report isn’t doom and gloom, it’s more a sign that “the Fed must remain patient” in its quest to tame inflation. “The narrative has not changed that the next move by the Fed will be a cut in rates,” he said.
