The Fed’s key inflation rate cooled in February; stocks go up

The Federal Reserve’s key inflation rate showed that February’s price pressures were less than expected as consumer spending softened. After the report, futures on the S&P 500 pointed to modest gains.


Perhaps the best news in the report was that non-housing services inflation has also cooled after running hot in recent months.

However, with inflation still well above the Fed’s comfort zone, it could take an abrupt rise in jobless claims or further evidence of bank fragility to avoid another May 3 rate hike.

Hits and misses of the PCE inflation rate

The price index for total personal consumption expenditure (PCE) rose 0.3% mom and 5% yoy, down from a downwardly revised 5.3% in January. Wall Street had expected a monthly gain of 0.4%. The 12-month PCE inflation rate should ease to 5.1%.

PCE core inflation, which excludes volatile food and inflation prices, also rose 0.3% over the month versus 0.4% forecast. Core inflation slipped to 4.6%, below forecasts of a stable 4.7%.

Personal spending rose 0.2% in February after being revised up 2% in January. Adjusted for price increases, spending on goods and services both fell by 0.1%.

Core PCE Services Inflation

The Fed usually emphasizes the core PCE inflation rate. As commodity price pressures ease, demand and supply chains normalize, and housing costs are expected to follow later this year, Fed Chair Jerome Powell has singled out core non-housing service prices as key to the inflation outlook. That’s because the prices of services from haircuts to health care to hospitality are closely linked to wages, which are generally the biggest cost driver.

In February, prices for core non-residential PCE services rose 0.3% on the month, compared with 0.5% in January and the smallest increase since July. This left the annual inflation rate for core non-residential services at 4.6%.

Fed rate hike outlook

Still, weaker inflation readings didn’t immediately have a major impact on the prospects for a May 3 Fed rate hike. The markets are now pricing in 53% chances a quarter-point hike, up slightly from 47% on Thursday.

Meanwhile, the two-year government bond yield rose 4 basis points to 4.14%.

S&P 500 reaction

S&P 500 futures rose 0.3% in early Friday trading following the inflation report. On Thursday, the S&P 500 rose 0.6%, hitting its highest level since March 6, just before the banking crisis began to snowball with the abrupt collapse of SVB Financial Group.

The S&P 500 closed 13.25% above its Oct. 12 bear market low, but remains 15.55% below its all-time high.

The recent rally has been led by tech stocks, particularly large tech stocks, amid the prospect of fewer Fed rate hikes due to stress in the banking sector. The Fed expects that tightening bank credit will slow the economy, so it doesn’t need to raise rates as much to bring down inflation. Still, inflation has a long way to go, so the Fed expects a recession, if not an outright one, which could weigh on S&P 500 gains.

Be sure to read IBD’s The Big Picture every day to keep up with market direction and what it means to your trading decisions.


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