Fed's Key Inflation Gauge: Will Rate Panic Ease?

This year, market expectations for the future direction of the Federal Reserve's interest rate policy have been like a roller coaster, and the next significant change may come again with the release of data. Recently, the tone of speeches by Federal Reserve officials remains cautious, and in conjunction with the fluctuation of economic data, U.S. Treasury yields have risen sharply this week. The market's pricing for rate cuts within the year is now less than two times, and the possibility of the first action in September is currently about 60%.

Price pressures are expected to cool slightly.

According to forecasts from Wall Street institutions, the year-on-year growth rate of the U.S. PCE in April will drop from the previous 2.8% to 2.7%, with a sequential growth rate of 0.3%. The core PCE year-on-year growth rate, excluding energy and food, is 2.7%, reaching a new low in nearly three years, and the sequential growth rate has fallen to 0.2%, reaching a low since December last year.

It is worth noting that Federal Reserve officials are closely monitoring changes in service prices within core inflation, which is crucial for controlling price trends.

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The previously released U.S. Consumer Price Index (CPI) for April met expectations, but the producer price (PPI) rebounded unexpectedly by 0.5% that month. Important components of PCE such as healthcare, hotel accommodation, and air tickets have risen, and service costs may be passed on to downstream consumers, thereby increasing the difficulty of further price declines.

Also announced alongside PCE are the monthly rates of personal income and personal expenditure. Institutions believe that the decline in non-farm employment and the stagnation of retail sales indicate that income growth and expenditure may also have slowed down. Both are of significant reference value for predicting future price trends. Consumer spending accounts for more than two-thirds of U.S. economic activity, and income expectations will slow consumer spending in the second half of this year, helping to control the upward pressure of demand on inflation.

Wells Fargo wrote in a report sent to reporters that the consumer sector continues to show resilience. Since the beginning of the year, the personal savings rate has been declining and is currently at a historical low of 3.2%. The steady rise in credit card debt and the low savings rate indicate that consumers are doing their utmost to maintain spending. Due to the earlier Easter than usual, the retail monthly rate cooled down, and personal expenditure in April will increase slightly by 0.3%.

In terms of income, the bank predicts a growth of 0.3%, lower than 0.5% in March. Although wage growth was strong in the first quarter, recent data indicate some loosening in the labor market and a slowdown in wage growth.

Michael Gapen, head of U.S. economic research at Bank of America Global Research, said that compared with the first quarter, the PCE price data, which is the Federal Reserve's favorite measure of inflation, should improve, "but it's just a tiny progress." He said.

Interest rate cut expectations have been pushed back again.The minutes from the Federal Reserve's meeting released last Wednesday showed that the Fed was shocked by the inflation data at the beginning of the year. Some policymakers even raised the possibility of raising interest rates. In addition, "some" officials saw the risk of financial conditions being insufficiently restrictive to slow down demand and inflation.

Starting next week, the Federal Reserve will enter a pre-meeting quiet period, and officials' remarks before that could be very important to the market. Minneapolis Fed Chairman Kashkari said in an interview with the American media this week that it would take several more months of robust inflation data to convince him that a rate cut is appropriate, and the most likely scenario is that interest rates will remain high for "some time."

Atlanta Fed Chairman Bostic, a current voter, believes that the improvement in inflation has slowed down, indicating that the FOMC needs more patience before lowering interest rates. Later this week, comments from New York Fed Chairman Williams will be in focus.

Bob Schwartz, a senior economist at Oxford Economics, previously said in an interview with Yicai that the bumpy road to a 2% inflation rate has taken another step. Service prices remain too high, largely influenced by labor costs, and the Fed believes that labor costs need to cool further to ease price pressures. He noted that the labor market is softening, wage growth is slowing, and he believes this will continue for the rest of the year.

Federal funds rate futures show that there is room for 1-2 rate cuts by the Fed this year, and compared to September, a shift towards a full re-pricing in November has been regained.

The reporter noticed that in the past two weeks, several institutions have adjusted their forecasts for Fed rate cuts. Goldman Sachs believes that the timing of the first cut is still a challenge. "A July rate cut is optional, just not urgent. By September, inflation may have improved significantly, but it's still not perfect, and some Fed officials still seem more worried about inflation and less willing to cut rates," the report mentioned.

Krishna Guha, Vice President of Evercore ISI, said that the hawks and doves of the Fed will engage in a dialogue over the next 3-4 months. The dovish argument is that the first-quarter inflation surge was mostly backward-looking, and the economy and labor market are slowing down, under which circumstances the Fed might cut rates. "The hawkish argument is that the economy is still too strong to reduce inflation, seeing a longer period of policy pause," he added.