My friend Bob Brusca (https://robertbrusca.substack.com/), Chief Economist at FAO Economics, kindly gave permission for me to share the following piece with readers. Bob has delved into the exquisite details of inflation measures and results he derived regarding them from the recent PCE report. The PCE is the Fed’s preferred inflation estimate. In ten minutes of reading one can easily see why the Fed’s future rate-cut policy is clouded. In my opinion the Fed is trying to tell us to be patient and that there is not sufficient clarity to forecast changes in the policy interest rate.
Market agents seem to be resisting this and pundits have only gradually reduced their forecasts of seven cuts coming to three. My best guess is that will give way to a two-cuts-coming forecast within the next month. Moving from market agents’ forecasts to my forecast, IMHO, there may end up being no cuts coming in 2024. Many of the reasons are discussed articulately in Bob Brusca’s work, which appears in full below. In my opinion, if there is continuing financial stability in the system, the Fed will move very slowly in making a policy change, because it doesn’t want to have to reverse its policy rapidly. The greatest risk to financial stability comes from the dysfunction of the US Congress and specifically the few politically selfish, intransigent members of the House of Representatives who are holding up votes on bills that 2/3s of their colleagues would agree to if those colleagues had the opportunity to vote on things that the very few are denying them.
Now here’s Bob Brusca. We thank Bob for permission to share this analysis with our readers. -David
The PCE report focus is on Inflation this month
PCE headline +0.3% core +0.3% both in February
Year on Year Core 2.8% (prev 2.9%); headline 2.5% (Prev2.4%)
CPI inflation and trends are MUCH WORSE than for the Fed’s preferred PCE
CPI runs a full percentage point Hotter in the Core over 6-MO and 12-Mo
The Road Ahead for PCE Inflation
So what does this mean?? The chart shows the core CPI and core PCE inflation rates have been moving higher. The core of the CPI has been moving higher more steadily, more relentlessly, and looks much more like a trend – an undesirable uptrend. The core PCE has a lot more volatility to it but it clearly has been moving higher as well. The gap between the PCE and the CPI has been very large especially in terms of month-to-month changes something that used to be unusual.
Looking Ahead- Looking ahead, the best way to think about annual inflation is that it is the product of 12-monthly percent changes; that product creates a year-over-year inflation rate. As we look at the simple monthly changes and the headline in the core of the PCE in the small table above, we are seeing what I call the ‘drop schedule’ of inflation rates as we look ahead over the next six-months. In March of 2024 the oldest of 12 month-to-month the percent change for the headline will drop out of the 12-month inflation calculation and a new one will be added. March 2023 (known, and presented in the table) will drop out, and March 2024 (as yet unknown) will be added. The headline change being dropped is an increase of 0.1%; for the core, an increase of 0.3% will drop out. That means, in March any increase in the PCE greater than 0.1% will accelerate the year-over-year inflation pace. For the core, any increase over 0.3% will accelerate the inflation pace and, any increase below 0.3% will decelerate the year over year inflation pace. To highlight these issues I have put in bold type in the table the numbers that are likely to create inflation accelerations on the measures as we look ahead and I put in red the numbers that are likely to create inflation decelerations in the period ahead.
The outlook by the numbers- Over each of the next three months the core inflation rate that will drop out, will be a monthly increase of 0.3%: in March, April, and May. For the core this sets up a period in which core inflation could well improve, that is if the pressure on inflation that we've seen recently is relieved, 0.3% is a ‘relatively high’ monthly inflation rate. Over the last six-months only two of the six-monthly core changes were below 0.3% m/m. The headline has three of the last six changes at 0.1% or less, two over0.3% and one at 0.3%. It’s an uneven record.
Probabilities, possibilities, no guarantees…There's no guarantee that just because the data are dropping 0.3% gains out, that the incoming data will be less than that. The problem for the economy is that service sector spending has picked up that inflation in the services sector is high and it's stubborn. We may see inflation in the future simply be higher and, in that case, you know what you have to compare to the future but you do know the future. The likely month-to-month inflation changes may be like the recent history of the changes I cite above, or conditions ahead might change.
Regardless of those metrics, were staring at some pretty bad CPI figures and clearly accelerating trend for CPI inflation (that could change either way as well). Federal Reserve officials have actually been careful to talk about inflation generally and to not try to draw an isolated bead on the PCE because it is performing better than the CPI. Federal Reserve officials have generally talked about inflation. They continue to remind us that their target is on the PCE but they also make a point of talking about CPI inflation because it's running so rogue. I think the Fed, despite having chosen the PCE as its target, is not eager to cut interest rates if the PCE is only slightly out of line at the same time that the CPI looks like it's greatly out of line. However, that's a judgement on my part and I can't say that reflects Fed policy in any way that I can defend.
Consumer spending an income trends
Spending is strong; the service sector is exceptionally strong- Consumer spending in February was relatively strong with the annualized real consumption spending at 5.2% based on 1.2% annual rate increase in goods spending and an outsized, 7.3% annual rate, for services. Trends show overall consumption at 2.4% over one-year, at a 3.2% pace over six-months, and at a 2.7% annual rate over three months. For services the spending trend is 3% over one-year, a 4.4% pace over six-months, and a 5% pace over three-months. The service sector is the job-producing sector of the economy. This sector appears to be quite strong, underpinning prospects for continued strong job growth and probably conditions that will maintain low unemployment rates. The service sector is likely to keep pressure on the labor market and that will mean upward pressure on wages which have been running at a pace excessive relative to the Feds 2% inflation target. It will likely underpin strong prices in the service sector as well.
Strong spending implies à In short, the performance of spending and what this trend likely means for the future does not really lay an environment that's hospitable for the Fed to continue to look for inflation to fall rather it seems to underpin higher inflation rates. Two months into the new quarter consumption is running at a 2.1% annual rate with declines in durable- and nondurable-goods spending and with services spending rising at a very firm 4.7% annual rate in the quarter-to-date. This simply elaborates the points that I made before about trend strength. These calculations apply to the actual spending in the quarter that is unfolding right now – not past trends.
At the same time there's some evidence that consumers are under stress as the savings rate has been falling. Over 12-months it's 4.4%, over six months it's 3.9%, it holds at 3.9% over 3 months, and falls to 3.6% in February. The declining savings rate suggests that consumers are spending faster than they're earning income, implying that they are reducing their savings in order to maintain current lifestyles.
Wrap up- The PCE report shows evidence that spending appears to be accelerating in a way that will put maximum pressure on the labor market and on service sector prices. On the other hand, we have evidence that spending may be excessive relative to income because the savings rate is falling. Does a spending slowdown lie ahead? February is a month in which the inflation rate went up for one of the PCE measures and down for the other one but only by a tick in each direction. And we're looking at a situation where PCE inflation is excessive as measured by the core or by the headline over anyone of the major tenors that we typically look at those being three-months, six-months, or 12-months. The inflation situation shows PCE inflation continues to look much better than CPI inflation, both in terms of the level of the inflation rate and the acceleration of the inflation rate. Still the future for the PCE pace hangs in the balance of economic spending trends that seem to offer more risk of more pressure than promise of relief. With the coming inflation data and the numbers that are due to drop out monthly form the annual calculation, the outlook is simply muddled. That's the PC for this month.
Links to other websites or electronic media controlled or offered by Third-Parties (non-affiliates of Cumberland Advisors) are provided only as a reference and courtesy to our users. Cumberland Advisors has no control over such websites, does not recommend or endorse any opinions, ideas, products, information, or content of such sites, and makes no warranties as to the accuracy, completeness, reliability or suitability of their content. Cumberland Advisors hereby disclaims liability for any information, materials, products or services posted or offered at any of the Third-Party websites. The Third-Party may have a privacy and/or security policy different from that of Cumberland Advisors. Therefore, please refer to the specific privacy and security policies of the Third-Party when accessing their websites.
Sign up for our FREE Cumberland Market Commentaries
Cumberland Advisors Market Commentaries offer insights and analysis on upcoming, important economic issues that potentially impact global financial markets. Our team shares their thinking on global economic developments, market news and other factors that often influence investment opportunities and strategies.
