The Latest PCE Data Spooked the Markets

This latest PCE inflation data spooked the markets and did not look good at the initial headline level. But digging into details, what really looked bad was the year-over-year Core PCE reading of 4.7% when expectations were 4.3%. JPMorgan economists concluded seasonal adjustment factors artificially drove up the numbers in this report and that the seasonal adjustments will roll off later this year and push the PCE back down.

We’ve had a string of disappointing inflation reports from the CPI, the PPI, and this latest PCE. But what they all have in common is a backwards-looking view. Forward-looking inflation indicators do not show any signs of revitalized concern. Look at any of the commodity benchmarks—the GSCI, the CRB, the Bloomberg commodity indexes—none of them are at levels that will feed into inflation pressure.

Housing prices declined for five consecutive months measured by the Case-Shiller Home Prices Index—and we get new Case-Shiller data on Tuesday. We’ve written many times about the lagged BLS survey methodology, but the Fed and Powell now recognize BLS housing data is distorted.

Yes, there was a window of higher activity for housing in January when mortgage rates cooled. But now mortgage rates are quickly surging back to 7%. Housing prices should come under pressure over the next few months and rental prices are also softening in real time data.

Inflationary expectations from the University of Michigan Consumer Sentiment survey also came out on Friday and there was no increase but rather a tick down in the one-year inflationary expectation. There is no sign consumer inflation expectations are becoming unmoored.

This week we will get another reading of the M2 money supply that declined in 2022 for first time since the Great Depression; I think this latest figure will show another monthly drop. This is not a healthy sign for the economy. The Fed should prefer to see this metric growing at longer run trends of 5% a year.

Putting all these forward-looking indicators together, I still see no reason for the Fed to panic and overtighten. Federal forecasts show the unemployment rate increasing 1 to 2%, causing three million people to lose their jobs. Of course, this has not showed up yet in any of the official employment statistics.

But even here, forward looking indicators from job recruiting websites show a softness in job postings and a surge in job searchers that has yet to show up in the JOLTS data reports. Peter Boockvar summarized the ZipRecruiter conference call and notes that ZipRecruiter’s revenue was down 15% in January, and they have many more job hunters, with a sharp pull pack in jobs listings. This could be an early sign for what is to come in the official statistics.

The February employment report could show a dip in employment, which would change the tone of market conversations around the path for interest rates dramatically.

I have been critical of the data quality in some of the official government inflation statistics. There is an interesting trend highlighted by Torsten Slok, an economist at Apollo. He pointed out the response rate to government surveys dropped from 70% to 35%. This also happened during the pandemic, but as survey responses tick down, the standard error of these surveys goes up and could give the Fed a misread on what is happening in the economy.

The markets pulled back on the higher interest rates and that is an expected reaction. But equities have not fallen more because the discourse now migrated from a ‘soft landing’ for the economy to the ‘no landing’ scenario with no major recession or earnings slowdown. If February’s employment data comes in hot again with over 250,000 jobs gained—a 50 basis point increase from the Fed at the March meeting would still be on the table. This would be a mistake in my view, but something that we will face in a few weeks as we get the next set of key jobs data.