PCE Review: On Track for June Fed Cut

Summary

• February core and headline PCE MoM inflation aligned with expectations, while January was revised up.
• February core PCE MoM was lower than January due to slower services inflation, especially excluding housing.
• Housing inflation was lower than January but has significant downside as a recovery in inventories of properties for sales is translating into higher vacancy rates.
• Core services inflation excluding housing fell sharply, partly due to January’s high print being an outlier.
• Even with pessimistic assumptions, core PCE is likely to clear the low bar set out by the Fed for a June cut.

Market Implications

• I agree with market pricing of about a two-thirds probability of a cut by June.

Core PCE Slows in February

As Chair Powell had announced in the 20 March presser, core PCE MoM was ‘well below 0.3%’ at 26bp. This aligned with expectations of 0.3% MoM and was down from January, which was revised from 0.4% up to 0.5%.

The details show a similar pattern to the February CPI: a marked decline in core services excluding housing led the slowdown (Table 1).

Core Goods Deflation Still Trending Down

Core goods inflation at 31bp MoM was higher than in February’s -5bp but overall remains on a downward trend (Chart 1).

Housing Inflation: Down With Significant Downside

February housing inflation at 44bp showed only a small slowdown relative to January’s 51bp (Chart 2).

However, I expect more downside. The recovery in existing home sales and inventories is pushing up vacancy rates (Chart 3). Higher vacancy rates in turn are lowering housing services inflation.

Supercore Services Inflation Slowed Sharply

February core services ex housing (supercore) inflation fell to 18bp MoM, compared with 66bp in January (Chart 4).

A breakdown of supercore PCE between its key components shows how much of an outlier January was (Table 2).

Market Consequences

Today’s print is consistent with Chair Powell’s view that ‘the overall story of inflation moving down gradually on a sometime bumpy road towards 2% had not changed’ (Chart 5).

The Fed has signaled a bias to cut this year by raising its 2024 growth and core PCE forecast while keeping three FFR cuts. Meanwhile, February core PCE YoY is 2.8%, only 20bp above the Fed’s Q4/Q4 2024 forecast of 2.6%. These suggest the Fed could cut in June if by then core PCE is marginally lower than February, for instance April core PCE at 2.7%.

YoY core PCE at 2.7% by the 12 June FOMC is realistic. It would represent an average core PCE increase of 28bp in March-April, which sounds feasible. Table 3 shows a scenario for core PCE that shows 28bp MoM can be reached even with the following pessimistic assumptions on disinflation:

• Core goods price inflation at 25bp/month compared with a January-February average of 13bp and H2 average of -20bp.
• Housing inflation slowing to 40bp MoM from 44bp in February and a 46bp H2 2023 average.
• Core services excluding housing accelerating to 25bp/month from 18bp in February and a 23bp H2 2023 average.

Overall, the March PCE keeps me expecting a first cut in June in line with markets currently pricing a two-thirds chance of a June cut.

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Dominique Dwor-Frecaut is a macro strategist based in Southern California. She has worked on EM and DMs at hedge funds, on the sell side, the NY Fed, the IMF and the World Bank. She publishes the blog Macro Sis that discusses the drivers of macro returns.

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(The commentary contained in the above article does not constitute an offer or a solicitation, or a recommendation to implement or liquidate an investment or to carry out any other transaction. It should not be used as a basis for any investment decision or other decision. Any investment decision should be based on appropriate professional advice specific to your needs.)