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Fed’s Key Inflation Rate Could Raise S&P 500


This rally in the S&P 500 is built on confidence that inflation will continue to decline steadily even as the US economy avoids a hard landing. December’s CPI data seems to reinforce that view as service inflation excluding housing fell to an annualized 1.2% in the fourth quarter. But the Fed’s focus is on the individual consumer spending price index. New data and data on Thursday and Friday could tell a much different story.




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Update PCE Inflation Rate

Investors will receive quarterly PCE inflation data on Thursday at 8:30 a.m. ET, along with the Q4 GDP report. December inflation data will be broken down with personal income and spending reports on Friday.

Wall Street expected Friday’s data to show the PCE price index flat in December, as the annual inflation rate fell from 5.5% to 5%. Core PCE price increased 0.3% as core inflation rate dropped from 4.7% to 4.4%.

However, Deutsche Bank economists warn that the last major inflation report before next week’s Fed meeting could bring bad news. They predict the core PCE price index will increase by 0.4% month-on-month, although the core CPI is up 0.3%.

Deutsche Bank’s economic team noted that the CPI report showed a 3.1% drop in airfares in December. The PCE price data for airfares, however, came from the producer price index, which showed an increase. 3.1% in the previous month.

PCE vs. CPI . inflation

That discrepancy only scratches the surface of the huge divergence between CPI and PCE inflation reports. Those differences have become a major issue for the trajectory of both the Fed and the S&P 500 policy.

PCE covers a much broader range of spending than CPI, which only reflects out-of-pocket spending. The distinction is especially important when it comes to health care, as the vast majority of medical bills are paid by employers, Medicaid, and Medicare. While health care services make up just 7% of the CPI’s household shopping basket, health care services make up nearly 16% of PCE.

Not only that, but the health services inflation gauge of the CPI started to decline rapidly in October and that will continue to happen as the source data regarding insurer profits is already on the books.

Powell’s new PCE service inflation measure also includes dining out, while food away from home is not included in the CPI’s services gauge.

Fed Chair Powell’s Most Important Inflation Rate

In his November 30 speech, Fed Chairman Jerome Powell acknowledged that commodity inflation has cooled and leading indicators of housing inflation suggest that rent pressures will decline sharply in 2023. However, he highlighted a new area of ​​interest for policymakers: core service inflation excluding housing.

Categories include healthcare, education, haircuts, hotels and more, accounting for about 50% of consumption. Powell calls it “the most important category for understanding the evolution of core inflation going forward.” That’s because price changes of such services are tied to wage growth. If the labor market remains extremely tight, high service inflation could persist.

The focus on core PCE services other than housing is so new that it was not covered in a Commerce Department report or a Wall Street thread estimate. IBD calculations show that the price index for PCE services excluding housing and energy rose 0.3% on the month and 4.3% from a year ago, down from 4.7 year-on-year gains. % adjusted up for October.

What does this mean for the S&P 500?

The S&P 500’s rally has stalled for the past two sessions, but the stock is still recovering. After falling as much as 1.7% in stock market volatility Wednesday morning, the S&P 500 has bounced off its 50-day moving average, cutting losses to just a fraction.

As of Tuesday’s close, the S&P 500 was 16.25% below its all-time high, but up 12.3% from its bear market low. on October 12.

Be sure to read the IBD Big picture every day to stay in sync with the underlying market trend and what it means for your trading decisions.

The S&P 500 is at a critical juncture, trying to maintain momentum above its 50-day line, which after several previous attempts was quickly reversed. A hotter-than-expected core PCE inflation reading comes at a bad time and could increase the likelihood that the Fed will increase by 75 basis points to the 5%-5.25% range. For now, financial markets expect the Fed to pause after a quarter-point rate hike next Wednesday and another one on March 22.

However, the real key to inflation and Fed policy is wage growth. The December jobs report showed wage growth slowing to a 4% annualized rate in Q4. If that regulation continues, the Fed will be more willing to wait and see than raise the benchmark interest rate past 5%. We’ll get two big wage growth reports next week, with the Q4 Employment Cost Index on Tuesday and the January jobs report on Friday.

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