The Federal Reserve’s primary inflation rate, the core PCE price index, slid to a 2% annualized rate in the third quarter, new Commerce Department revisions revealed on Thursday. The surprisingly tepid inflation data come ahead of Friday’s release of November inflation data that economists expect to be equally tame, if not more so. The data sent the S&P 500 higher and the 10-year Treasury yield lower.
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The fall in inflation to the Fed’s 2% target in Q3 on an annualized basis even amid strong economic growth helps explain why policymakers are beginning to worry less about an inflation resurgence.
Fed Rate Cut Odds Grow
Financial markets are now betting that the Fed will cut its key policy rate to 3.8% by the end of 2024, down from 3.83% ahead of the revised PCE and GDP data. That’s because the rapid ebbing of inflation is making the current 5.25% to 5.5% range of the federal funds rate look increasingly restrictive.
Market pricing now shows 83% odds that the first rate cut will come at the March 20 meeting, up from 79% on Wednesday. Markets now see 42% odds of 1.75 percentage points in rate cuts next year, up from 38% a day ago.
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.
November PCE Inflation Data
The Dec. 12 update of the consumer price index for November showed core prices rose 0.3% on the month. However, the producer price index, which was released on the morning of the Fed’s Dec. 13 policy statement and projections, pointed to a much softer reading for the core PCE price index, and that probably played into Fed chair Jerome Powell’s dovish outlook.
The consensus estimate is for a 0.2% rise in core prices, which should lower the annual core PCE inflation rate to 3.4% from 3.5% in October. Yet forecasts for the monthly rise in the core PCE price index range from 0% to 0.2%, suggesting a strong chance of a positive surprise.
Meanwhile, the headline PCE price index, which includes food and energy, is expected to be flat from October, lowering the annual increase to just 3%.
GDP, Jobless Claims
However, the annual inflation rates may come in below forecasts made ahead of Thursday’s GDP revisions. For Q3, the core PCE price index rose at a 2% annualized rate, revised down from 2.3%. Headline PCE inflation was cut to a 2.6% annualized rate from 2.8%.
The economy grew a revised 4.9% in Q3, down from the prior estimate of 5.2%, due to somewhat more moderate estimates of consumer spending.
Friday’s November inflation data is part of the Commerce Department’s monthly personal income and outlays release. Economists are forecasting a 0.4% rise in personal income and 0.3% increase in spending.
The trend of disinflation and solid growth appears to have continued in Q4. Separate data on Thursday showed initial claims for jobless benefits edged up 2,000 to 205,000 in the week through Dec. 16. The four-week average eased by 1,000 to 212,000, which is only modestly above the lowest level of 2023 (199, 500 in January).
S&P 500, 10-Year Treasury Yield
The S&P 500 rose 0.6% in Thursday morning stock market action, 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 Thursday, the 10-year Treasury yield fell as low as 3.83%, a level last seen in late July. However, the 10-year Treasury yield firmed up to 3.87%, down just one basis point from Wednesday.
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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