Note: This new story was published after the release of inflation data on Thursday
The key Federal Reserve inflation gauge, the core PCE price index, is expected on Thursday to show that price pressures continued to moderate in October. Yet after tame consumer price index data unleashed the S&P 500's biggest move of its explosive four-week rally, there's some chance of an upside surprise reading for core inflation that cools things down.
The CPI report on Nov. 14 seemed to close the door on the possibility of an additional Fed rate hike. An above-consensus reading on core PCE price inflation on Thursday morning might pry that rate-hike door open just a crack and push back the expected timing of rate cuts.
However, Wednesday's second estimate of third-quarter GDP growth came with good news for the Fed. Although growth was actually a bit stronger than the initial estimate, 5.2% vs. 5.1%, the core PCE price index rose at a 2.3% annual rate in Q3, revised down from 2.4%.
Yet the inflation rate for core PCE services excluding housing was actually revised up to 3.7% from 3.5%. The Fed has highlighted that category of spending as key to the inflation outlook because service-price trends are closely linked to wage growth. Meanwhile, soft inflation in Q3 largely reflects outright declines in prices for core goods, like autos, cell phones and apparel, which fell 2.1%.
Fed's Waller Talks Pivot
If there was any doubt that rate hikes are done, Fed Gov. Christopher Waller's dovish turn on Tuesday likely settled the matter. Waller, who has been a fixture of the hawkish consensus, said he's "increasingly confident that policy is currently well positioned to slow the economy and get inflation back to 2%."
Not only that, but Waller said rate cuts would be warranted if inflation continues to ease over the next three to five months.
The surprise was that a reliable hawk turned dovish despite the S&P 500's surge and the dive in the 10-year Treasury yield. In a speech titled "Something Appears To Be Giving," Waller explained that his confidence in the outlook stems from evidence the economy is slowing in the fourth quarter.
PCE Price Index Forecasts
Wall Street economists expect the personal consumption expenditures price index will edge up just 0.1% amid energy price declines. That would bring the annual PCE inflation rate down to 3.1% from 3.4% in September.
The core PCE price index is seen rising 0.2%, following a 0.3% increase in September. Analysts expect the Core PCE inflation rate will fall to 3.5% from 3.7%.
However, Deutsche Bank economists expect another 0.3% monthly rise in core prices, with the Fed's key core inflation rate only dipping to 3.6%. They note that a couple of PCE inputs reported in the producer price index came in stronger than their CPI counterparts.
Health care services rose 0.5% in the PPI vs. 0.3% in the CPI. Domestic airfares rose 0.8% in the PPI's measure of average cost per mile, while falling 0.9% in the CPI's measure based on the cost of certain routes. Also, unlike the core CPI, the core PCE inflation gauge includes food services, whose prices rose 0.4% in October.
However, a 2.9% drop in portfolio management costs in the PPI could blunt the rise in the core PCE price index. The portfolio management costs are imputed from market data like stock returns, which went south in October. Of course, portfolio management costs are likely to surge in November.
Federal Reserve Impact Of PCE Inflation Rate
The current S&P 500 rally took flight on Nov. 1, when Federal Reserve chair Jerome Powell said that the tightening in financial conditions with the rise in the 10-year Treasury yield could reduce the need for further short-term rate hikes. But that's only if the tightening in financial conditions is persistent, he stressed.
Markets haven't heeded that latter message. The subsequent 10-year Treasury yield dive and S&P 500 surge appeared to raise the stakes for incoming jobs and inflation data. Yet Waller's remarks raised another possibility — that the Fed will formalize the end to rate hikes in its Dec. 13 policy update.
Yet Powell may not be ready to declare victory over inflation, especially if Thursday's PCE inflation data and the Dec. 8 jobs report show strength.
Federal Reserve Rate Cut Odds
As of Wednesday morning, markets see the slimmest odds, just 1.5%, of a rate hike on Dec. 13. For the next Federal Reserve update on Jan. 31, markets see the chances as equally tiny rate cut or a rate hike, with 97% odds the status quo will hold, according to the CME FedWatch Tool.
Further out, markets price in about 75% odds of a rate cut at the May 1 meeting. For the full year, markets lean toward five quarter-point rate cuts. That would drop the Fed's key lending rate to a range of 4% to 4.25%.
The Fed's quarterly September projections showed just one quarter-point rate cut in 2024 from current levels. If core PCE comes in hotter than expected, December projections are likely to present a significantly more hawkish outlook than markets now anticipate.
Personal Income And Spending
The Commerce Department's personal income and outlays report, out at 8:30 a.m. ET on Thursday, also is forecast to show modest 0.2% growth for both income and spending.
Such modest increases could add to confidence that the economy is downshifting and a soft landing is just ahead.
S&P 500 Setup
The S&P 500 scratched out just a 0.1% gain in Tuesday stock market action, despite Waller's remarks that sent the 10-year Treasury yield tumbling 5 basis points to 4.34%, a two-month low.
However, the S&P 500 rose a moderate 0.4% early Wednesday, as core PCE inflation was revised down for Q3 and the 10-year Treasury yield headed still lower to 4.28%.
The S&P 500 has rallied 10.7% over the past four weeks, the best four-week gain since last fall's bounce off bear-market lows.
Be sure to read IBD's The Big Picture column after each trading day to get the latest on the prevailing stock market trend and what it means for your trading decisions.
