PCE week: But the narrative feels all too familiar

It's a holiday week in the US. Still, the economic calendar remains packed, including an update on the Fed's preferred inflation gauge, which will be released on Good Friday, albeit likely commanding limited attention unless there is an unexpected surprise. Still, there will be enough chop to rock the boat at times, but unlikely to tip it.

The narrative surrounding the PCE update feels all too familiar at this point and a bit stale: The "median" Fed official still leans towards three rate cuts in 2024. However, critics of Fed policy contend that this stance appears out of sync with the inflation landscape, where underlying price growth may stabilize above the 2% mark.

Speculation abounds that the Fed might be content with the longer-term downward trend of inflation or could quietly target a higher inflation threshold. This could be due to various factors, such as the Fed interpreting the Q1 bump in prices as seasonal or actively fostering a robust economy in the run-up to the election. It's conceivable that a combination of these motivations is at play.

As highlighted in a recent update, investors have shifted their focus away from the exact number of rate cuts the Fed will implement this year or the timing thereof. What matters more is the clear signal that the trajectory of policy rates is downward, not upward, from here. Last week's developments affirmed this sentiment.

Economists anticipate a 0.3% month-on-month increase in the core PCE reading scheduled for March 29. However, this forecast is already on the warm side. Any deviation to the upside from the consensus would be met with unease, particularly in light of the recent overshoot in the PPI.

Typically, I would attach significance to the release of February's core PCE numbers. However, given the recent data from CPI and PPI, forecasters (and the Fed) are already confident in the consensus forecast of +0.3%. Chairman Powell has also indicated that the inflation trajectory observed in January and February aligns with the expectation of 75 basis points of rate cuts.

In last week’s press conference, Chair Powell emphasized that, in his view, the disinflation narrative remains intact despite the overshoots observed in January and February. Consequently, Powell's remarks inadvertently signalled that Friday’s PCE release might be inconsequential in shaping monetary policy decisions.

Still, even in holiday conditions, the behaviour of quants in electronic markets remains unpredictable. While the drop in liquidity could potentially amplify directional moves, it's also worth noting that with the US bond market closed, the first opportunity actually to trade the news will be the following Monday. This extended period could lead investors to contemplate the significance of the data release, adding an extra layer of uncertainty to the market dynamics at the following Monday open.

Also on the agenda for the holiday-shortened week in the US: New home sales data, updates on national home price indices, the Conference Board's consumer confidence report, pending home sales figures, and a series of speeches from Federal Reserve officials.

Bottom line: Despite persistent inflationary pressures and the Fed's willingness to cut rates amid this backdrop, critics continue to find fault with the central bank's approach. However, it's possible that we are entering a new paradigm where slightly elevated prices become a norm. This sentiment is underscored by similar actions from central banks like the BoE and ECB, which also consider rate cuts amidst elevated inflation.