PCE: Hot or Not?

The upcoming Personal Consumption Expenditures (PCE) report is expected to show that core price levels rose by 0.2% in April. If the actual figure hits the mark, it would reflect higher inflationary pressures compared to the 0.1% uptick seen last March. It would also be in line with the 0.2% core CPI figure we saw a few weeks back.

Looking at the trend in PCE for the first few months of this year shows that inflation has been climbing steadily. After holding steady in December 2009, core PCE posted a 0.1% increase in January and was followed by a 0.2% rise in February. Slowly but surely does it!

Still, there’s no denying that inflation remains very much subdued in the U.S. As I pointed out in one of my older articles on the Fed inflation outlook, it looks like Big Ben and his men were right in predicting that the recent spike in price levels was merely transitory. The recent CPI figures proved just that!

Now that the April PCE reading could confirm the Fed’s belief that inflation would remain tamed, chances are that the central bank will most likely stick with its current monetary policy stance. After all, the PCE is rumored to be the Fed’s preferred measure of inflation.

But why is that?

Well, the PCE probably paints a better picture when it comes to measuring consumer inflation. That’s because it takes changing consumer preferences into account by comparing price levels from quarter to quarter instead of using a fixed base. Unlike the CPI – which has used one set of expenditure weights for several years now – the PCE makes use of varying weights to account for the changes in consumption in the previous quarter.

Looking at recent economic data, I doubt we’ll see the PCE report show rising inflation.
For one, while this month’s headline CPI report showed a 0.4% increase in consumer prices, the core report, which does not include food and energy prices, only rose by 0.2%. Remember, it’s important for us to be comparing apples and apples, so you should take note that the core PCE index also excludes food and energy prices. Chances are we’ll see similar results in tomorrow’s core PCE index.

Looking at another major underlying factor, unemployment is still a recurring headache in the U.S. The unemployment rate is now back at the 9.0% mark. Meanwhile, weekly jobless claims are still hovering above the psychological 400,000 barrier.

How can momma go on a shopping spree if she has no paper to burn??? And if momma ain’t spending, you can bet that companies are in no rush to be raising prices as well!

Vegas odds are that the PCE index report could be a dud and show subdued inflation. What does this mean? Well, if it really is the preferred measure of the Fed, then perhaps this will just give the Fed more reason to keep interest rates in the ice box!

This also means that the dollar probably won’t be getting any help from the Fed. Due to the Fed’s stance towards interest rates, the dollar has been susceptible to interest rate differentials. Watch out though, because once the Fed even starts hinting of raising rates, chances are the markets will act quickly and start establishing some long dollar positions!