Inflation Easing as Federal Reserve Monitors Monetary Policy

by Warren Seah

The Federal Reserve closely monitors the core personal-consumption expenditures (PCE) index, also known as the core PCE deflator, as its preferred measure of inflation. Recent data suggests that price increases are losing momentum, which could impact the stock-market rally driven by expectations of a potential shift in monetary policy by the Fed in early 2024.

According to a survey of economists conducted by FactSet, the core PCE index is projected to have risen 3.5% in October, slightly lower than the 3.7% increase seen in September. Similarly, headline PCE inflation, which factors in the volatile food and energy prices excluded from the core PCE calculation, is expected to have risen 3.1% in October, down from a 3.4% increase in September.

Should these projections hold true, both core and headline PCE levels would represent the lowest inflation numbers since spring 2021. This marks a significant milestone and brings us closer to the Fed’s desired target of 2% inflation, which has been the focus of interest-rate hikes initiated by the central bank since March 2022.

Economic Data Release and Market Expectations

The upcoming releases of PCE inflation readings, scheduled for 8:30 a.m. Eastern on Thursday, are anticipated to have a significant impact on the stock market. Currently, the market is experiencing an upward trend, largely driven by the hopeful prospect of reduced inflation that would discourage the Federal Reserve from further increasing borrowing costs. In fact, the S&P 500 has achieved an impressive 8.1% growth in the month leading up to Thanksgiving – its best performance during this period since 1999. Investors have been closely monitoring the inflation data and are already preparing for rate cuts expected next year. Consequently, traders are observing a decline in the value of the dollar, which recently hit a three-month low, as lower interest rates are projected.

While PCE inflation readings are always significant to both investors and the Fed, this release holds particular importance due to its timing. It serves as the final PCE print and major inflation indicator before the commencement of the Fed’s two-day monetary policy meeting on December 12th. Additionally, investors should look out for the consumer price index (CPI) and producer price index (PPI) readings to be released on December 12th and 13th, respectively.

Market expectations indicate a growing sentiment that the Fed will adopt a more dovish stance. With that in mind, traders are adjusting their forecasts and factoring in as many as seven rate cuts in the upcoming year, according to the CME FedWatch Tool. On Wednesday, the probability of rates being lowered during the Fed’s March policy meeting rose to over 50%, a substantial increase compared to Tuesday’s less than 35%. Furthermore, the likelihood of a rate cut by May has also significantly risen above 80%.

These developments highlight the market’s anticipation of more accommodative monetary policies in the near future, suggesting potential shifts in investment strategies. As investors react to the upcoming economic data, their actions will undoubtedly impact the direction of the stock market.

The Impact of Inflation Data on Rate Expectations and Stock Market Performance

As the global economy experiences ongoing changes in rate expectations, the stock market has been responding with remarkable resilience. In this context, the release of new inflation data takes on added significance, potentially bolstering the market’s upward momentum or introducing a degree of caution.

The relationship between rate expectations and the stock market is a complex and ever-evolving one. As investors digest the latest inflation figures, they will undoubtedly scrutinize the data for any indications of how monetary policy might be adjusted in response. This scrutiny is driven by the understanding that interest rates can have a profound impact on various aspects of the economy, including borrowing costs, consumer spending, and corporate profits.

Given the current market climate, where swift shifts in rate expectations have become the norm, the release of this latest batch of inflation data is highly anticipated. Investors are keen to gain insights into whether these figures will support or challenge prevailing notions about future monetary policy decisions.

If the new inflation data affirms expectations for stable or lower interest rates, we may see a continuation of the recent stock market rally. Such an outcome would provide further validation for investors who have been emboldened by accommodative monetary policies. On the other hand, if the data suggests a potential uptick in inflation, it could prompt a reevaluation of rate expectations, potentially dampening market enthusiasm.

In summary, the forthcoming release of inflation data carries considerable weight and has the potential to shape market sentiment in the coming weeks. Investors will pay close attention to these figures, hoping to gain valuable insights into the trajectory of interest rates and their subsequent impact on stock market performance.

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