Stocks, Bonds, Dollar: How Today’s PCE Report Could Drive Market Moves

Fed’s Preferred Inflation Gauge Set to Impact Rate Cut Decisions

The Federal Reserve’s preferred inflation measure, the Personal Consumption Expenditure (PCE) price index, will be released Thursday, with implications for rate policy as the year-end approaches. Investors anticipate the data will confirm an ongoing disinflation trend, reinforcing expectations for Fed rate cuts in early 2024. The CME FedWatch tool currently signals a high likelihood of a rate cut at the upcoming Fed meeting, but the December rate cut probability stands at a less certain 70%.

Anticipated PCE Data and Economic Insights

Analysts predict September’s headline PCE inflation rate will decline to 2.1% year-over-year, slightly down from August’s 2.2%, with a monthly uptick to 0.2%. For core PCE, which excludes food and energy and is closely watched by the Fed, projections suggest a modest dip to 2.6% annually but with a notable monthly rise to 0.3%.

Analysts like Bank of America’s Shruti Mishra highlight Q3 core inflation’s resilience, which could be due to recent upward revisions. Goldman Sachs has raised its expectations, forecasting a monthly 0.26% rise in core PCE, translating to a 2.65% annualized rate—potentially indicating persistent inflation pressure.

UBS economist Alan Detmeister, however, expects PCE to remain near the Fed’s 2% target, largely driven by energy price declines. He cautions that this level may be temporary, as energy prices could rebound. Additionally, persistent wage growth in the service sector, especially in labor-intensive industries, may sustain inflation, noted economist Belinda Román. Strong wage growth could increase pressure on core inflation as wages tend to be “sticky.”

Market Reactions and Volatility Potential

Market sentiment on rate cuts remains mixed. A rate cut next week is widely anticipated, yet the likelihood of a December cut is less certain. Should the PCE data confirm slowing inflation, markets are likely to react favorably, with equities expected to rise and bond yields, particularly on shorter-term maturities, likely to decrease.

A higher-than-expected core PCE, however, could impact the Fed’s stance. Deutsche Bank cautions that an inflation surprise may prompt the Fed to hold rates steady, raising bond yields and cooling equity market optimism. In such a scenario, a stronger dollar could also weigh on stocks while increasing bond market volatility.

Dollar and Euro Sensitivities

The U.S. dollar is in focus, poised to weaken if the PCE report supports rate cuts. Conversely, stronger-than-expected PCE data could strengthen the dollar if it leads to a delay in rate reductions. The euro, meanwhile, has risen on stronger Eurozone GDP growth and German inflation data, temporarily reducing expectations for ECB rate cuts.

Market Outlook: Bullish or Bearish?

• Bullish Scenario:
  • Confirmed disinflation in PCE data would bolster the Fed’s case for rate cuts, boosting equity markets and driving down bond yields.
• Bearish Scenario:
  • Higher-than-anticipated core PCE could lead to a bearish shift, with increased bond yields, a stronger dollar, and pressure on stocks.
• Fed’s Inflation Analysis:
  • In addition to PCE, the Fed will examine employment cost data, making Thursday’s report critical to its rate decision.

The U.S. Department of Commerce’s release of the September PCE data will provide the Fed with pivotal information for its upcoming rate decision. While recent strong economic data supports a “soft landing” scenario, any upside surprise in PCE could strengthen the case for holding rates steady. As Deutsche Bank’s analysis suggests, persistent inflation and labor market resilience could prompt a rate-hold in November. Thursday’s PCE report will be crucial in guiding the Fed’s next steps and setting a tone for market behavior through year-end.