What does it mean for the Fed if Core PCE turns out to be weaker than expected?

What does it mean for the Fed if Core PCE turns out to be weaker than expected?

If the personal consumption price index is “as expected”, will that be enough for the Fed to leave rates unchanged at its February meeting?

The US Personal Consumption Expenditure Price Index (Core PCE) would be the Fed’s preferred measure of inflation, as it captures the most significant data for the Fed outside of food and energy. On Friday, the December Core PCE will be released in the US. Inflation is expected to be 4.4% y/y compared to 4.7% y/y in November. If the result is in line with expectations, it will be the fourth consecutive monthly decline in inflation. But what will this mean for the Fed?

The FOMC’s expectations have already fallen short when it meets next week. After the December meeting, markets were expecting a 50 basis point gain in February. However, after the release of worse-than-expected economic data during January, expectations were lowered due to fears of a recession.

The average hourly wage for December fell sharply. The consumer price index fell in December for the first time since May 2020. Retail sales, industrial production and manufacturing output were negative and below expectations. Many believe that the housing market is already in recession.

However, Fed members walked out in January with comments pointing to a 25 basis point increase on Feb. 1. According to the CME Fedwatch tool, the markets estimate the probability of a 25 basis point rate hike with 100% certainty.

Fedwatch CME Tool

Source: CME, Stone X

The Bank of Canada raised rates by 25 basis points on Wednesday and said it was pausing its rate hike cycle to assess whether monetary policy was tight enough. The inflation rate in Canada is 6.3% on an annualized basis. Australia just released its RBA-adjusted average consumer price index, which was 6.9% year on year. What if the underlying PCE for December turns out to be weaker than the expected 4.4% yoy? Would it matter if the FOMC went up 25 basis points? Can the FOMC surprise the markets and leave rates unchanged? Maybe it could signal a breakout like the Bank of Canada. Whether Core PCE is weaker or stronger, the Fed’s rate hike cycle is almost over.

This may help explain why the US dollar has been weak against the euro. The EUR/USD pair has been in an uptrend since the publication of data on weak average hourly growth on January 6th. In the 4 hours chart, the EUR/USD bounced off the lower trend line of the ascending channel.

Over the past 2 weeks, the price of the EUR/USD pair has fluctuated around the upper trend line and is forming a rising wedge. If markets continue to believe that the Fed will remain dovish (or if the ECB continues to be more hawkish), the price should continue to rise in a rising wedge ahead of the Fed meeting.

Previous highs from April 21, 2022 cross slightly higher at 1.0936.

However, if the market decides to take profits ahead of the Fed (remember, the Fed is in a blackout period), then the EUR/USD could decline. Note that the price is expected to break below the rising wedge and pull back 100% or 1.0766. Below, EUR/USD may return to the lower channel trendline and horizontal support around 1.0635.

EUR/USD 4-hour chart

inflation eurosd fed dollar january 2023Source: Tradingview, Stone X

The Fed’s preferred inflation measure, Core PCE, will be released on Friday. The index is expected to rise by just 4.4% year on year. Note that the Fed is targeting inflation at 2%. If the results are “as expected”, will that be enough for the Fed to leave rates unchanged at its February meeting? Perhaps, at the very least, this will force the Fed to signal a pause in March.

But if it turns out to be stronger than expected, as it was with the Australian CPI earlier in the day, wait for the Fed to raise rates by 25 basis points and continue raising rates by 25 basis points “as needed”.

Joe Perry, CMT, » Official site stock exchange fomc

Disclaimer: The information and opinions contained in this report are for general information only and do not constitute an offer or solicitation to buy or sell any currency contracts or CFDs. Although the information contained herein has been obtained from sources believed to be reliable, the author does not guarantee its accuracy or completeness and accepts no liability for any direct, indirect or consequential damages that may result from anyone relying to such information.

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