The US Inflation Tracker captures the trends that provide context in today’s economy.

Inflation Could Be at Target by Summer 2024
The Federal Reserve’s preferred measure of inflation, core PCE (Personal Consumption Expenditures price index) is the number to watch, not CPI (Consumer Price Index). It’s not about CPI. And it’s not about core CPI. It’s all about core PCE. Inflation is not reaccelerating. Year-over-year numbers are distorted by prior year base effects. It was never going to be a straight line to 2% inflation. It wasn’t a straight line up, so don’t expect it to be a straight line down. The trend is what matters and that trend is very much intact.

Based on the differences between the CPI and PCE baskets, we expected the wedge between these measures to grow throughout 2023. However, that growing divergence should now begin to close as CPI catches down to PCE. The key point to take away – CPI is likely overstating inflation relative to PCE and PCE is fast approaching the Fed’s 2% target.

Five components of the inflation basket are driving an estimated 13 basis point wedge between core CPI and core PCE for December. And these components have been repeat offenders of late: motor vehicle insurance, airfares, imputed financial services, health insurance, and medical care services ex-insurance. These line items have a scope and methodological differences in what prices are included and how they are calculated when comparing the CPI and PCE, resulting in a wedge between the two inflation measures. But CPI along with PPI (Producer Price Index) can inform us of what PCE might look like – and all indications are for a more encouraging PCE print on January 26. If we string together several consecutive months of a 0.20% month-on-month print on core PCE, the Fed’s 2% inflation target could be well within reach by summer. And that means no reason for the Fed’s restrictive rate policies to persist.

Potential Core PCE Trajectories (12/31/18–6/30/24)
Potential Core PCE Trajectories (12/31/18–6/30/24)Source: Natixis Investment Managers Solutions, Bloomberg

Is the Market Pricing In Too Many Rate Cuts?
We hear plenty of talk that the market is getting ahead of itself pricing in Fed rate cuts. Looking at the headline rate cut expectation numbers, it certainly appears that the market may be a little too giddy, pricing in nearly 150 basis points of cuts in 2024 beginning as soon as the March meeting.

However, this interpretation might be missing the mark. The market’s pricing doesn’t reflect a single discrete outcome. Rather, it reflects the probability-weighted distribution of potential outcomes. The consensus seems to be leaning into the soft landing, which likely yields 3–4 cuts as this mid-cycle adjustment by the Fed gets us back to a more neutral interest rate (vs. the current restrictive one).

On the other hand, the market also reflects tail pricing – more cuts in a hard landing scenario and more hikes if inflation reaccelerates. We can also think of this as disaster insurance – some investors are happy to make a small wager on these tail events as the payoffs can be handsome (especially relative to the cost). With the right tail of more hikes being cut as the path towards 2% becomes clearer, probabilities have to shift to other potential outcomes, dragging the probability-weighted average lower.

In aggregate, the market may be reflecting nearly 6 cuts in 2024, but the modal outcome is 3–4 cuts, very much in line with the most recent dot plot in the Fed’s Summary of Economic Projections. Perhaps there’s some risk of an unwind of recession hedges that could push short rates modestly higher. But by the Fed’s own admission, a soft landing warrants 175 basis points of easing by year-end 2025 as inflation cools back to 2.1%, a threshold that could feasibly be reached before year-end 2024.

If there’s an overshoot of pricing by the market, it’s with respect to timing as opposed to level. But when assessing market pricing through the lens of probability-weighted outcomes, the market looks much more in line with the Fed’s guidance. And that’s 3–4 cuts – not the 6 that some are espousing.

Implied Probability of Fed Rates Cuts as of 1/14/24

Implied Probability of Fed Rates Cuts as of 1/14/24Source: Natixis Investment Managers Solutions, Bloomberg

Resource

US Inflation Tracker – January 2024
This in-depth chart deck highlights historical data related to:
• Personal consumption
• Inflation surprises
• Goods and services
• Base effects and surges
• Supply chain, shipping, and restocking
• Housing market pressures
• Wage pressures
• Inflation expectations


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This material is provided for informational purposes only and should not be construed as investment advice. The views and opinions contained herein reflect the subjective judgments and assumptions of the authors only and do not necessarily reflect the views of Natixis Investment Managers, or any of its affiliates. The views and opinions expressed are as of January 16, 2024, and may change based on market and other conditions. There can be no assurance that developments will transpire as forecasted, and actual results may vary.

All investing involves risk, including the risk of loss. Investment risk exists with equity, fixed income, and alternative investments. There is no assurance that any investment will meet its performance objectives or that losses will be avoided. Investors should fully understand the risks associated with any investment prior to investing.

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