Investors skirt a warm PCE inflation print

Markets

Amid persistent optimism surrounding artificial intelligence, Thursday saw the S&P 500 and Nasdaq Composite continue their ascent, marking a positive trend for the major averages as they headed towards a successful month for investors. This positive momentum persisted despite the release of the consensus PCE print.

The personal consumption expenditures price index, considered the Federal Reserve's preferred inflation gauge, showed a 0.3% rise in January compared to December. Similarly, the core index, which excludes volatile food and energy prices, saw a 0.4% increase. These figures aligned with economists' expectations, and given the upward trajectory of stocks throughout the year; some investors perceived the absence of hotter-than-expected inflation news as a less problematic macro signal.

Indeed, market participants continue to focus on the broader bullish sentiment, especially in sectors associated with artificial intelligence, which continues to drive the sustained upward trajectory of major market indices. This trend persists despite indications of sticky inflation at the beginning of the year.

The resilience of investor optimism in sectors related to artificial intelligence underscores broader confidence in the potential for technological innovation to fuel economic growth and corporate performance.

All in all, at the end of the day, it seems that investors were lathered in relief, especially those who were concerned that inflation would accelerate further, potentially leading the Fed to delay rate hikes for an extended period or, worse, to initiate rate increases again.

The PCE warmer reality 

While the quickest and warmest inflation PCE development in a year is likely not the ideal setup, it could have been worse.

Leading up to the release, the BLS stirred controversy with an email sent to so-called "super users," indicating that the high reading on rental inflation in the January CPI release was partially attributed to the calculation method rather than actual inflation. This communication added a layer of complexity to the interpretation of the inflation data. This is an absolute PR comedy show.

Following the email, which raised concerns among recipients regarding the calculation of rental inflation in the January CPI release, the agency attempted to retract its statement, urging recipients to disregard the previous communication. However, this attempt to rectify the situation came after the news spread, leading to confusion and speculation.

Meanwhile, Bloomberg journalist Matthew Boesler encountered difficulties obtaining information as inquiries were redirected among government departments, raising questions about the reliability of everything the BLS is doing.

The Federal Reserve has consistently emphasized its reliance on data to inform decisions regarding monetary policy. So, if the data is unreliable, where does that leave most who are not " super users"?

Lathered in relief

From a cross-asset perspective, the component in the PCE data still underscores the challenges the Fed may encounter in navigating monetary policy amid evolving inflationary conditions. Excluding energy and housing, services inflation surged by 0.6% last month compared to December. This type of inflation, often called "sticky" inflation, represents a significant challenge for the Fed and overall price dynamics. The 0.6% increase marks the most robust growth in services inflation since March of 2022, a notable period coinciding with the Federal Reserve's interest rate liftoff.

Although the in-line core inflation readings might lather a bit of relief, especially as the event risk is now behind us, which can sometimes serve as a bullish catalyst on its own, it's essential to acknowledge that the warmer, bordering on hot inflation data underscores the prevailing belief that navigating the final stretch of managing inflation will likely be a challenging and uneasy journey for all. However, we join the prevailing belief that the direction of travel is lower.

Forex markets

149.20 Given How Are You Left?

If you are a dollar-yen trader like us, you should expect some volatile times leading up to the next Bank of Japan meeting as traders jump on and off the BoJ policy hamster wheel. As we suggested yesterday, if not for the constant and overly noisy PCE coverage, USDJPY would have traded closer to 149 ( 149.20 was the low post-PCE). 

Still, given the noisy end-of-month rebalancing, especially with fully hedged funds needing to adjust Yen hedges after spectacular gains on Tokyo stocks this month, I would not read too much into mid-day New York price action that coincides with WMR London Fix, where month-end rebalance noise tends to crescendo 

A drop below 140 USD JPY (135 is our H2 target) will also require support from the Fed to initiate rate cuts, narrowing the policy divergence with the Bank of Japan (BoJ). But currently, the recent series of robust US economic activity and inflation data at the beginning of this year challenges any bearish US dollar outlook.