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Why is Today’s US PCE Deflator Important?

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Later today we could have some market fluctuations. This can be attributed to a host of key economic data coming out in the US, just as American traders are getting to their desks.

One of the potential outcomes is a reversal in the dollar’s trajectory.

So far this week, the market has been adjusting to the uncertainty of when the Fed might start tapering its bond purchases. However, at the same time, there is a recalibration in the market because of how important inflation data is.

Up until eight days ago, there was a pretty strong consensus that the Fed would stick to supporting the jobs market and not pay as much attention to inflation.

So what has changed? What can we expect from today’s PCE deflator?

What makes the PCE special?

To begin with, there are many different ways of measuring inflation.

The most popular way to do so is the Consumer Price Index. The CPI is compiled by a survey of how much consumers are spending on products within a determined basket.

Another measure is the Personal Consumer Expenditures or PCE. This is a survey of businesses and it offers a more accurate representation of the consumers’ buying habits.

So, while CPI measures, for example, the change in the price of rice, PCE measures how much money people are spending on rice, and if they’ve substituted it for another product.

PCE sounds like a more precise method, right?

So how does this affect the market?

In fact, since 2012, the Fed has been primarily using PCE to understand the evolution of inflation. Moreover, this is the data series experts use to try and figure out what the Fed will do next.

Right now, we really want to know when they will start tapering their asset purchases, and when they will raise rates.

If the PCE index is rising, we can interpret this as an indication of higher inflation. Therefore, this could mean that the Fed is more likely to do something about it. More specifically, we want to look at core PCE, because that’s the measure excluding the more volatile products of food and energy.

Additionally, economists use the difference between the PCE figure and the CPI figure to estimate the evolution of prices, and whether or not inflation is accelerating or slowing down.

What we are looking for

The other major piece of data coming out today, at the same time, is the durable goods orders from May.

Generally, this is a good measure of the underlying health of the economy, because they represent whether people are making long-term investments. In fact, this is likely to get more media coverage, as investors try to gauge how strong the recovery is.

Specialists expect the durable goods orders to accelerate to 2.8%, compared to -1.3% in April. Excluding defense, they anticipate the orders to remain largely flat, with a range of projections from 0% (the prior month’s figure) to just +0.2%.

Finally, we want to pay attention to the Initial Jobless Claims, which we can expect to fall slightly to 380K, from 412K in the prior week. This could be seen as a welcomed change, as the recent data has shown a break in the downward trend.

However, a number higher than 410K might suggest a weakness in the jobs market and weigh on risk sentiment.

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