US Core PCE Slows to 2.1%, Most Dovish Print of the Cycle

The US core personal consumption expenditures inflation slowed to 2.1% year-on-year in April, the BEA reported on Friday, the lowest reading since February 2021 and within rounding distance of the Federal Reserve's 2% target. This slowdown is significant as it suggests the Fed's efforts to curb inflation are bearing fruit. On a month-on-month basis, core PCE rose just 0.13%, the softest monthly print since the disinflation cycle began. This downtrend in inflation is a crucial development for the Fed, which has been closely monitoring the inflation data to determine its next course of action.

The deceleration in core PCE was broad-based, with various components contributing to the slowdown. Core goods prices fell 0.1% month-on-month, indicating a decline in the prices of goods. This decline is a welcome sign for the Fed, as it suggests that the supply chain disruptions and other factors that drove up goods prices in the past are starting to ease. Core services excluding shelter rose just 0.15%, a relatively modest increase that suggests the services sector is not driving inflation higher. Shelter inflation, which has been a persistent concern, continued its slow grind lower at 0.32%. This slowdown in shelter inflation is a positive development, as it suggests that the housing market is starting to cool down.

The implication of this reading for the Fed is significant. The material slowdown in core PCE inflation tilts the balance toward a September rate cut. Futures-implied probability of a September move has risen to 87% from 64% before the print. This increase in probability suggests that market participants are becoming increasingly convinced that the Fed will cut rates in September. The Fed's decision to cut rates will depend on various factors, including the overall state of the economy, the labor market, and inflation expectations. However, the latest core PCE reading suggests that the Fed may have more room to maneuver than previously thought.

The mechanics of the disinflation cycle are complex, and the Fed's actions have played a crucial role in shaping the inflation outlook. The Fed's decision to raise interest rates aggressively in 2022 helped to curb demand and reduce inflationary pressures. The subsequent slowdown in economic growth has also contributed to the decline in inflation. However, the Fed's actions have not been the only factor driving the disinflation cycle. Global economic trends, including the slowdown in China and the eurozone, have also played a role in reducing inflationary pressures. The interplay between these factors will continue to shape the inflation outlook in the coming months.

For allocators, the slowdown in core PCE inflation has significant implications for capital allocation. The prospect of a September rate cut increases the attractiveness of fixed income assets, as lower interest rates make bonds more appealing to investors. The slowdown in inflation also suggests that the economy may be entering a period of slower growth, which could impact the performance of equities and other risk assets. Allocators will need to carefully consider these factors when making investment decisions, as the outlook for the economy and financial markets remains uncertain. The Fed's actions will continue to play a crucial role in shaping the investment landscape, and allocators will need to stay vigilant to navigate the changing market conditions.

The latest core PCE reading is a significant development in the ongoing debate about the Fed's monetary policy stance. The slowdown in inflation suggests that the Fed's efforts to curb inflation are working, and the prospect of a September rate cut increases the likelihood of a more dovish monetary policy stance. However, the Fed will need to balance its desire to support the economy with its mandate to keep inflation in check. The coming months will be crucial in determining the Fed's next course of action, and allocators will need to closely monitor the economic data and the Fed's communications to make informed investment decisions. The slowdown in core PCE inflation is a positive development, but it is not a guarantee of a rate cut, and allocators should remain cautious in their expectations.

In conclusion to this analysis of the core PCE data, the slowdown in inflation is a complex phenomenon with multiple factors at play. The Fed's actions, global economic trends, and domestic economic conditions are all contributing to the decline in inflation. As the Fed considers its next move, allocators will need to carefully consider the implications of a potential rate cut for their investment portfolios. The attractiveness of fixed income assets, the performance of equities, and the outlook for the economy will all be impacted by the Fed's decision. By closely monitoring the economic data and the Fed's communications, allocators can make informed investment decisions and navigate the changing market conditions.