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PCE, Income & Spending Suggesting Peak Inflation?

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Friday, January 28, 2022

Personal Consumption Expenditure (PCE) data hit the tape, in all its numerical tedium. Yet within these tea leaves lie lots of useful data for the Fed in its monetary policy decision-making, among other things. So while they may be harder to follow than, say, monthly employment numbers (out next week, by the way), they are at least as important.

PCE Inflation for December came in on the headline at +0.4%, down from the +0.6% posted for November. Core PCE, which strips out volatile pricing month over month, was +0.5%, as expected and exactly in-line with the prior-month’s read. Year over year, PCE Inflation bumps up 10 basis points to +5.8% from November, while the Core PCE Inflation year over year change came to +4.9%, higher than the +4.8% estimate and the +4.7% the previous month.

Why this is significant is because in order to see a year-over-year PCE deflator number as high as +5.8%, you’d have to go back to 1982. The core deflator’s +4.9% year over year was the highest we’d seen since September of 1983. We’re talking 40 years or so. So we are officially, clinically at our highest inflation points in the U.S. economy since President Reagan’s first term. And the financial dynamics back then were such that they might be highly unrecognizable to market participants of today.

Yet pre-market activity liked the news very much: whereas ahead of the print we saw the Dow -280 points, the Nasdaq -97 and the S&P 500 -33, mere minutes later we were -100 points on the Dow, -8 on the S&P and the Nasdaq swung to +14 points. This is because, while the PCE data is high, it’s coming down. Especially on the headline +0.4%, down 20 basis points month over month — and in the heart of holiday shopping season.

Are we seeing consumers resisting higher prices? That would be an organic taming of inflation to a certain extent right there. And if this holds, it’s even possible that we’re seeing a peak in the inflation rate RIGHT NOW. And if that’s true, even as the markets are pricing in four or more interest rate hikes this year alone, will the Fed need to hike rates that much? If they don’t, aren’t we then oversold?

OK, that’s a lot of question marks. That’s fitting, as pre-market trading ebbs more bearish by the paragraph. We don’t know yet, is the simple answer. But the clues are here to at least acknowledge the potential for near-term hopefulness.

The Q4 Employment Cost Index fell greater than expected to +1.0%, from +1.3% in Q3 and +1.2% expected. Meanwhile, Personal Income dropped to +0.3% last month; it was expected to rise 10 basis points to +0.5%. Consumer Spending reached -0.6% for December, generally in-line with expectations but a big swing from the +0.6% reported in November, and the 15-year-high +0.7% posted for October ’21. Yet more evidence that we may be peaking on the inflation front.

We, of course, need more data to be definitive on this. And as Frank Sinatra once sang, “Fools rush in where angels fear to tread.” But we expect portfolio managers to game out strategies that suppose we are at market lows right now; nobody wants to be left behind when high-grade companies’ current -20% discounts suddenly evaporate. Basically, a bullish narrative is on the radar now.

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