Federal Reserve’s favoured inflation gauge accelerated in January

The Federal Reserve’s preferred measure of inflation rose more than expected in January, triggering a Wall Street sell-off as investors weighed the prospect of interest rates staying higher for longer as the central bank fights stubborn price pressures.

The personal consumption expenditures (PCE) price index, which measures how much consumers are paying for goods and services, increased 0.6 per cent month on month, after rising 0.2 per cent in December. The annual rate increased to 5.4 per cent in January from an upwardly revised figure of 5.3 per cent a month earlier.

The so-called core PCE index, which strips out volatile food and energy costs and is the Fed’s preferred inflation metric, rose 0.6 per cent in January, up from 0.4 per cent in December. The annual rate increased to 4.7 per cent from an upwardly revised figure of 4.6 per cent in December, missing economists’ expectations for a moderation to 4.3 per cent.

The figures were the latest in a string of new data releases including on employment, retail sales and other price gauges that have come in hotter than expected, prompting markets to factor in the prospect of US interest rates going higher and staying there for longer than they had expected.

Following Friday’s figures, investors priced in a 39 per cent chance of a half-point rate rise at the Fed’s March meeting, compared with an 18 per cent likelihood a week ago, according to CME Group’s FedWatch tool. Bets on a quarter-point rise dropped from 82 per cent to 61 per cent over the same period.

Cleveland Federal Reserve president Loretta Mester on Friday said the Fed should lean towards pushing interest rates higher to get inflation back down to the central bank’s 2 per cent target.

“In my view, at this point with the labour market still strong, the costs of undershooting on policy or prematurely loosening policy still outweigh the costs of overshooting,” said Mester at the annual US Monetary Policy Forum hosted by the University of Chicago Booth.

Following the February Fed meeting, Mester had said that she would have supported a half-point increase, versus the quarter-point raise that was announced. According to the minutes from that meeting, “a few” officials said they would have preferred a larger increase in rates, or could have been persuaded to support one.

US president Joe Biden said in a statement that the latest figures showed that “we have made progress on inflation, but we have more work to do”. He insisted that the economy had “continued to make progress since the data in this report”, pointing to a recent downward trend in petrol prices.

Stocks were under pressure on Friday as investors adjusted their interest rate expectations. The S&P 500 closed 1.1 per cent lower on the day, taking the blue-chip index’s loss for the week to 2.7 per cent, which marked the biggest weekly drop since December. The Nasdaq Composite finished Friday’s session 1.7 per cent lower.

“[The data] underscores the difficulty the Federal Reserve has in restoring price stability as consumers continue to spend at a healthy pace,” said Quincy Krosby, chief global strategist at broker LPL Financial.

Bonds fell and yields moved higher as investors factored in the latest upward pressure on borrowing costs. Yields on benchmark 10-year notes rose 0.07 percentage points to 3.95 per cent, close to a three-month high hit earlier this week. Rate-sensitive two-year yields also rose and, at 4.81 per cent, were at their highest since the summer of 2007.

“It is far too early . . . to buy the dips in bond prices, let alone trying to continue to buy the dips in the stock market,” said Chris Zaccarelli, chief investment officer at Independent Advisor Alliance. “We have been exercising much more caution and have advised our clients to be careful and not aggressive at this point in the economic cycle.”

Fed chair Jay Powell warned earlier this month that taming inflation would take a “significant period of time”.

Friday’s PCE data is consistent with the January consumer price index that registered a smaller monthly decline than expected as services inflation remained elevated.

Personal consumption rose in January to 1.8 per cent from a revised decrease of 0.1 per cent in December, according to Bureau of Economic Analysis data on Friday. That missed economists’ expectations for an increase of 1.3 per cent. Inflation-adjusted personal spending increased 1.1 per cent in January.

The PCE data showed that personal income growth quickened to 0.6 per cent in January from 0.3 per cent in December, but below economists’ expectations for a 1 per cent increase. The personal savings rate increased to 4.7 per cent in January, from 4.5 per cent in the previous month.