Core PCE (YoY) Declines to Lowest Level Since March 2021

Rates rise on PCE day. The swap/yield curve bear flattenedafter PCE data came in largely as expected and personal spending proved robust,the short end rising as many as 6bps. Today’s move largely offset yesterday’s decline, and rates were little changed on the week as a result. Meanwhile, the SPX ended its streak of 5 consecutive days with new all-time highs, though today’s decline was miniscule. In the Middle East, significant Houthi strikes set fire to a Trafigura Group ship, which forced Brent crude to a two-month high of ~$84 per barrel.

Longer-term PCE measures show inflation keeps falling, but today’s data offered little support for March cuts. Core PCE inflation, the Fed’s preferred measure, was 2.9% on a YoY basis in December, below expectations and marking an eleventh-straight month of declines. On a 6-month annualized basis, core PCE inflation was 1.9%, the second month that the measure was below the Fed’s 2% target. Though these longer-term measures were positive, elevated personal spending (and November’s upward revision) coupled with higher core and headline inflation on a MoM basis offer the Fed room for patience before easing. Futures currently suggest a ~50% chance for a 25bp rate cut in March and largely expect an incremental 25bps of easing in May.

Treasury Secretary Yellen points to the possibility of higher “neutral” interest rates. JanetYellen said today that “the jury’s still out” on where interest rates will settle in the long-term. She pointed to an increased probability that rates remain elevated above COVID levels, as economic resilience “suggests that perhaps productivity growth and potential output growth have increased and the level would be higher.” Though Yellen called elevated long-run rates a “fiscal positive,” concerns would be raised over the government’s debt burden and increased financing costs.