Patience: Inflation's Message to Fed

There's an old adage about Federal Reserve rate cycles: the Fed takes the escalator up and the elevator down. Because of the deleterious impact higher rates has on the economy, the Fed is usually more methodical when hiking rates. On the other hand, the Fed has historically been more aggressive when cutting rates, especially when combatting recessions. This time is different.

Rate Cuts and Rate Hikes

For illustrative purposes only.

Given the pandemic-related surge in inflation, the Fed embarked on the most aggressive tightening cycle in more than 40 years—moving the fed funds rate off the zero bound in March 2022. With 11 hikes overall between then and last July—and four consecutive 75-basis-point hikes therein—the Fed clearly took the elevator up. With the Fed in "pause" mode for now, attention has turned to the coming rate cut cycle. The rub is the lack of cooperation by inflation data, which has been a bit sticky this year and not yet at the Fed's 2% target.

With that as a backdrop, let's review the latest inflation readings. This past Friday, with the markets closed, February's PCE (personal consumption expenditures) deflators—preferred by the Fed—were released. As shown in the charts below, headline PCE rose 0.33% month-over-month, putting the year-over-year increase at 2.5%. Core (ex-food/energy) PCE rose 0.26% month-over-month, putting the year-over-year increase at 2.8%. Unfortunately, the three-month rates of change have hooked up meaningfully, while January's month-over-month increase was revised higher. A focus of the Fed has also been core services ex-shelter (not shown below), which did tick down to 3.3% year-over-year.