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Market Reaction to Friday’s PCE Report May Have Been Wrong

This post originally appeared on April 2, 2023

PCE Rockets Market:

On Friday, we got the new PCE report. That stands for Personal Consumption Expenditures and it’s the preferred measure of inflation for the Federal Reserve. While it doesn’t get the same attention as the Consumer Price Index (CPI), it’s probably more important in determining Fed policy.

The new PCE showed inflation for consumers was up 5.0%. This was both below last month’s 5.3% and below expectations. The “low” reading was the primary reason for the S&P 500 to be up 1.4% on Friday with the NASDAQ up even more at 1.7% on the day. The market has been looking for the Fed “pivot” to lower interest rates since 2Q last year. DKI has been insisting for almost a year that expectations for the pivot were very premature and incorrect. We’ve been right about this so far.

At some point, the “pivot people” will be right. The Fed won’t keep raising rates forever, and we’re much closer to the end than the beginning. However, we’re not sure the market is getting this one right for several reasons:

5% is still huge:  The Fed has a mandate for “stable prices”, but they’ve modified it to mean inflation of 2%. That doesn’t sound like much, but over a 40-year working life, 2% inflation destroys 55% of the value of your money. 5% means an 86% loss in that time. These are huge numbers and the 5% rate (while down from 5.3% last month) is still more than double the rate the Fed wants.

Powell is terrified of sustained inflation:  In the 1970s, the Federal Reserve wasn’t aggressive enough in crushing inflation. They paused rate hikes when the CPI was around 5% figuring that the CPI was on the way down and everything would be fine. It wasn’t fine and the result was the massive inflation of the late ‘70s and early ‘80s. The next Fed Chairman, Paul Volker, raised rates to almost 20% which was both the correct action and caused a recession. Powell is aware of this history and wants to be remembered as a “Volker”, not as the guy who let the huge inflation numbers of the last year and a half last more than a decade.

The services number is a big problem:  Services is the area where Fed actions have less impact. It’s also the category that most affects American’s economic lives. We’re seeing a huge wage/price spiral where higher prices cause workers to demand higher wages leading to higher prices in the future. With more than 10 million jobs available, demand for labor right now is huge. The services PCE was up 5.6%, the highest reading in almost 40 years. We can assure you the Fed is watching this number very closely.


Again, at some point, the Fed will pivot. The market believed Friday’s PCE was the turning point. Barring some unforeseen events in the next month, we think Friday’s rise was premature. No change to our market hedge position.


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Information contained in this report is believed by Deep Knowledge Investing (“DKI”) to be accurate and/or derived from sources which it believes to be reliable; however, such information is presented without warranty of any kind, whether express or implied and DKI makes no representation as to the completeness, timeliness or accuracy of the information contained therein or with regard to the results to be obtained from its use.  The provision of the information contained in the Services shall not be deemed to obligate DKI to provide updated or similar information in the future except to the extent it may be required to do so. 

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