No Government Shutdown, but a Compromise on PCE Inflation

Over the weekend, there was a positive development for the United States as Congress reached an agreement to temporarily fund the government for an additional 45 days, averting a looming shutdown. However, it's worth noting that we might find ourselves in a similar situation in less than seven weeks. Nevertheless, for the time being, we can enter the fourth quarter with a semblance of normalcy. Official data will still be released this month, which is crucial as we approach the October 31-November 1 FOMC meeting and strive to gauge the state of the economy as the year draws to a close.

Another piece of good news arrived last Friday in the form of the August PCE inflation report, which was relatively reassuring. Both headline and core inflation met consensus expectations for annual price growth, standing at 3.5% and 3.9%, respectively. While the headline figure rose compared to July, primarily due to increasing energy prices, core inflation dipped below 4% for the first time since June 2021. The monthly core increase was a mere 0.1%, the first instance of such a reading since late 2020. It's evident that this critical indicator, closely monitored by the Federal Reserve, is decelerating.

In fact, if we continue to witness monthly core PCE readings of 0.1%, we will see 2% annual price growth (excluding food and energy) by February 2024. Should the monthly pace of increase average 0.2%, we could reach 2% core inflation by the end of the next year. In every scenario, a clear and consistent decline is evident, which is likely to provide reassurance to both the Fed and the financial markets. This leads me to believe that, if we take a middle-of-the-road approach, the Fed may delay rate hikes and perhaps even begin rolling back restrictive policies by the second quarter of next year. I maintain my view that the first-rate cut is unlikely to occur until May next year, and it seems that the Fed has concluded its rate-hiking cycle.

Additionally, the annualized price growth rate over the past three months has also been showing signs of slowing down. Annualized core PCE inflation has now moderated to just 2.2%, while headline inflation has declined to 2.4%. Looking at the past six months, the annualized figures stand at 3.0% for core PCE and 2.6% for headline inflation, respectively. Clearly, there is a trend emerging that favours the Federal Reserve's objectives.

The often-mentioned "Powell super core" inflation rate, named after the Fed Chair, who frequently highlights this metric as a concern, is also on a downward trajectory. Core services excluding housing have exhibited remarkable resilience, maintaining an annual rate of over 4% since April 2021. In August, we observed a 4.4% yearly increase, which is the slowest rate since September 2021 when it increased by the same margin. To find a lower reading, we would have to go back to May of that year.

Furthermore, the monthly reading for this price category, much like the overall core inflation, registered a mere 0.1% increase in August. This represents its slowest pace since November of 2020, nearly three years ago. 

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