Summary: US core PCE price index up 0.6% in January, greater than expected; annual rate accelerates from 4.6% to 4.7%; US economy starts year stronger than previously expected; Treasury yields higher; Fed rate-rise expectations harden.
One of the US Fed’s favoured measures of inflation is the change in the core personal consumption expenditures (PCE) price index. After hitting the Fed’s target at the time of 2.0% in mid-2018, the annual rate then hovered in a range between 1.8% and 2.0% before it eased back to a range between 1.5% and 1.8% through 2019. It then plummeted below 1.0% in April 2020 before rising back to around 1.5% in the September quarter of that year. It has since increased significantly above the Fed’s target.
The latest figures have now been published by the Bureau of Economic Analysis as part of the January personal income and expenditures report. Core PCE prices rose by 0.6% over the month, greater than the 0.4% increase which had been generally expected as well as December’s 0.4%. On a 12-month basis, the core PCE inflation rate accelerated from December’s revised rate of 4.6% to 4.7%.
“Overall, the reality is that the US economy has started 2023 from a stronger position than many of us had expected and when we look at the Fed’s new preferred inflation reading that tries to exclude much of the noise in the data, the story doesn’t change,” said NAB Senior FX Strategist (Markets) Rodrigo Catril.
US Treasury bond yields increased on the day, especially at the short end. By the close of business, the 2-year Treasury bond yield had jumped 11bps to 4.80%, the 10-year yield had gained 7bps to 3.95% while the 30-year yield finished 4bps higher at 3.93%.
In terms of US Fed policy, expectations of higher federal funds rates over the next 12 months generally hardened. At the close of business, contracts implied the effective federal funds rate would average 4.665% in March, 9bps higher than the current spot rate, and then climb to an average of 4.88% in April. May futures contracts implied a 5.12% average effective federal funds rate while December contracts implied 5.305%.
The core version of PCE strips out energy and food components, which are volatile from month to month, in an attempt to identify the prevailing trend. It is not the only measure of inflation used by the Fed; the Fed also tracks the Consumer Price Index (CPI) and the Producer Price Index (PPI) from the Department of Labor. However, it is the one measure which is most often referred to in FOMC minutes.