Inflation growth keeps falling.
One of my most vivid memories of the COVID pandemic was rediscovering lunch. The moment that I fondly remember was realizing my favorite deli, The Wine Merchant, was still open for business.
You see, for the initial three to four weeks of the pandemic, my wife, children, and I really didn’t leave our neighborhood. Other than going to the grocery store for food or Target for things like cleaning supplies, we kept to ourselves. But, after talking with friends who were still going into the office and getting take-out lunch, I was jealous. And the next day, I headed out for a sandwich.
One thing you need to understand is that I’m a creature of habit. So, I can go for years getting the same thing for lunch every day. And my go to sandwich is turkey with Swiss cheese and Dijon mustard on rye, add a half order of salami. In addition, I grab a bag of UTZ barbeque chips and two bottled cokes. If prices change, I notice.
When I first showed up, I still paid the same $12 I had prior to COVID. Then as time dragged on, I noticed prices started to creep up. By the end of the first year my lunch cost $15… Within two years it was $18… And by the end of the third year it had risen to $20. But lately I’ve noticed a change…. The price has held steady.
To get a visual of what I’m talking about, look at the price of white bread over the same time frame…
In the chart above the price of white bread was $1.36 at the end of 2019. In the early part of 2020, prices held steady. Then, by the end of the year, they had jumped 13% to $1.54. In 2021, prices held steady before surging 21% in 2022. In 2022, the pace of growth slowed, increasing another 8%. But this year, the price of bread has stabilized and eased.
This dynamic reminds me very much of the national inflation picture. As the cost of goods has risen, demand has cooled. Individuals may not be eating lunch out as much as they used. The dynamic shift tells me that price pressures should ease more when August personal consumption expenditures are reported at the end of September. That will support more rate cuts this year by the Federal Reserve and underpin a steady rally in risk assets like cryptocurrency.
But don’t take my word for it, let’s look at what the data’s telling us…
If we want to get an idea of what PCE growth looks like, we need to study the big picture. So, we must observe the number on an annualized basis. That way, we don’t let any one-off monthly surges distort the more important long-term picture.
The headline PCE index component breakdown works out to be roughly 35% goods and 65% services. So, services are going to have a bigger influence on the gauge’s direction. However, core PCE (minus food and energy) is what we really want to watch.
So, let’s take it a step further. Food and energy fall under non-durable goods (last less than three years). That subset makes up around two-thirds of the PCE goods part, with durable goods (last longer than three years) making up the other third.
Read more: Scott Garliss – The Fed Must Have Confident Consumers
The central bank likes to remove food and energy because the prices are volatile. That way, policymakers feel like they’re smoothing out the numbers. So, when we back them out of the inflation equation, we’re left with a core PCE index that is largely made up of services prices.
Now, let’s take a closer look at the services component. It accounts for the divergence between the BEA and BLS inflation measures. That’s why PCE growth tends to be shallower than the CPI.
In PCE, housing including utilities is roughly 17%, healthcare is about 17%, financial services and insurance is around 8%, other services almost 8%, food (remember service side) and accommodations is roughly 8%, recreation services 4%, and transportation around 3%. That’s vastly different from CPI where housing makes up over 36% while medical services is just 6%.
According to BLS, in August, shelter prices rose 0.5%, medical care services contracted 0.1%, financial services decreased 0.3%, insurance costs declined 0.2%, hotel room costs rose 1.8%, recreation services were unchanged, and transportation and warehousing services slid 0.1%.
If we adjust those numbers on a weighted basis, we get an almost 0.2% increase for August. That’s in-line with the Federal Reserve Bank of Cleveland and consensus expectation for 0.2% growth.
So now, let’s look at what year-over-year growth will look like at 0.2%…
According to my forecast, 0.2% monthly growth would translate to 2.7% core PCE on an annualized basis. That would be in-line with Wall Street’s expectation for a 2.7% increase but below the Cleveland Fed’s forecast of 2.8%.
More importantly, the average rate of growth over the last six months would be running at 0.2%. That would translate to 2.4% core growth on an annualized basis. That would be below the current rate and implies the pace should continue to slow moving forward.
If PCE plays out as I expect, it will boost the outlook for easier money policies from the Fed. Because based on the new rate of inflation and the effective fed funds rate, real interest rates will have a 2.7% cushion to the downside before they stop weighing on inflation growth.
In other words, the change will give our central bank plenty room to start cutting interest rates without stoking an inflation rebound. That should support the outlook for economic growth to slow, but not collapse, and underpin a steady rally in risk assets like bitcoin and ether.
Note: The views expressed in this column are those of the author and do not necessarily reflect those of CoinDesk, Inc. or its owners and affiliates.
