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US PCE Could Decide Trajectory for the Fed

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Friday has the release of a key bit of data that could seal the fate of the dollar for the rest of the year. That’s because it’s the preferred inflation measure for the Fed, and could resolve an important conundrum for the market.

There has been a monetary policy situation brewing most of the year, and it’s now coming down to the wire with just two more rate decisions left for the Fed. Broadly speaking, it’s expected that the Fed will keep rates steady through all of next year. But at what rate is still an open question, and one that could drive the dollar at least for the rest of the year.

What’s going on?

Even after last week’s “hawkish pause” by the Fed, the markets and the central bank still don’t agree on what’s going to happen with interest rates for the rest of the year. The Fed’s statement pointed to there still being a high chance of there being a rate hike before the start of 2024. Which means either in November or December. The latter is seen as less likely, because hiking into the winter is generally understood to have a bigger negative impact on the economy.

On the other hand, over 80% of traders see no rate hike in November. Over 60% still believe there will be no more tightening by the Fed. Tomorrow’s release of PCE data is the last one of the Fed’s preferred inflation measures to become available before the next FOMC meeting. In other words, whether or not the Fed will hike next month could largely rely on the data to be published tomorrow. Sure, there are still the September CPI figures to be released in a couple of weeks time that can also have an impact. But, as long as they don’t come out wildly different from the expectations set by the PCE, the projection for what the Fed will do in November could be set tomorrow.

What to look out for

Monthly core PCE Price index is expected to remain unchanged at 0.2%, for the third month in a row. That isn’t all that surprising, since the Fed has been in pause mode for the last couple of meetings. It’s also a rate that isn’t far off the Fed’s target, and below the current rate. That might leave Fed officials comfortable enough to not raise in November. But, a mere decimal higher would imply a change in trend for inflation that could put a surge on bets that the Fed will hike.

The core PCE annual rate is expected to come down to 3.8% from 4.2% thanks largely to base effects. That means that the increase last year at this time was larger than the increase in prices this year. That is why the annual rate can come down while the monthly rate stays the same.

What other key indicators are there?

The thing is, the Fed can keep rates high for a while, as long as the economy keeps growing. Or even raise rates if there is plenty of GDP expansion. The US consumer is the largest driver of the economy, so in order to make sure the economy keeps going at the current rate, people need to be able to afford their current spending.

The September data is expected to continue a worrying trend that Americans are increasing their spending to keep up inflation. But incomes are not keeping pace with that spending, leading to more borrowing. At a certain point, they won’t be able to borrow more, and the economy could start slowing down. September personal spending is forecast to increase at 0.6% compared to 0.8% prior; while personal income is expected to increase at just 0.3% compared to 0.2% prior.

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