Summary
- This morning's PCE report shows that the monthly rate of change for inflation continues to move in the right direction.
- It also shows that the Fed's year-end target of 4.8% for the core rate is way too high.
- The increase in the year-end target was the impetus for the increase in the target for the terminal Fed funds rate.
- A lower starting point for inflation in 2023 should result in a lower terminal rate for Fed funds, which should be bullish for risk asset prices.
Stocks gave back their prior day's gains yesterday on news that third-quarter GDP was revised up to 3.2% from the initial estimate of 2.9%, due largely to more robust consumer spending on services. The Personal Consumption Expenditures ((PCE)) price index for the quarter was also revised up one-tenth to 4.7%. This raised concerns that the Fed would have to push harder on the brakes to slow growth, which translates into higher interest rates for longer, but this is a silly assumption. The third quarter is ancient history and irrelevant in terms of what next year will bring on the spending and inflation fronts.
That brings me to this morning's PCE report for November, which is the Fed's preferred measure of inflation. It revealed that prices increased just 0.1% last month, which was below the 0.2% expected, but the increase in October was revised up from 0.3% to 0.4%. We saw the same dynamic in the core rate, which was in line with expectations at 0.2%, while the increase in October was revised up from 0.2% to 0.3%. Still, the rate of change continues to be a positive one. More importantly, this shows that the Fed's year-end estimate for inflation is way too high, and the consensus of economists is not far behind.
As I mentioned two days ago, in its Summary of Economic Projections, the Fed increased its estimate for the core PCE from 4.5% to 4.8% for 2022. According to Chairman Powell, this higher launching pad for 2023 was the primary reason that members raised their terminal target rate for Fed funds from 4.6% to 5.1%. Yet the 0.2% monthly increase in November requires that December realize an increase of 0.6% or more to result in an annualized 4.8%. Why would inflation surge that much in the final month of the year, given the deceleration in prices we are seeing in December? It should not.
Federal Reserve
I expect we will see another increase of 0.2% or less for December, which will force the Fed to reduce its year-end projection back down to the 4.5-4.6% range, which is where it stood in September. In the same vein, a lower starting point for inflation should result in a lower terminal Fed funds rate. We will not have confirmation of this until late January when the December number is reported, but that will come before the Fed's next meeting on February 1. The next Consumer Price Index report will arrive sooner and give us more insight. The bottom line is that today's report shows that the rate of inflation is falling faster than both the Fed and bears contend. I think this increases the chances we see a Santa Claus rally to finish the year.
For further details see:
Inflation Is Falling More Rapidly Than The Bears Or Fed Contend