U.S. Dollar and the Fed's Top Inflation Gauge: Analyst and Economist Views

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January's Core Personal Consumption Expenditures (PCE) Price Index was potentially an early warning of a nightmare scenario being in the pipeline for policymakers at the Federal Reserve (Fed) but analyst and economist views on the outlook for interest rates and the Dollar inevitably remain far from uniform.

Dollars were in demand in the final session of the week while U.S. bond yields were higher across the board after the Core PCE Price index picked up on the month in a January outcome that lifted the annual pace of price growth 10 basis points to 4.7% when it had been expected to fall to 4.3%.

This measure of inflation is the Fed's the target and the most closely watched because it's seen as better able to measure domestic price pressures, making Friday's data especially pertinent in the context of recent hopes for an all-out retreat back to the two percent target. 

The data disrupts a multi-month cooling that had been widely viewed and in some cases declared as the beginning of a disinflation process that many said would quickly take all measures of inflation back to the desired level.

It comes after the Federal Open Market Committee (FOMC) voted in February to lift the Fed Funds rate by 0.25% to 4.75%, bringing it into line with the September 2022 FOMC forecasts but still leaving some way to go before it's consistent with the December projections. 

The December set of forecasts suggested the benchmark would likely sit anywhere between 5% and 5.5% by the time the interest rate cycle is done, although Friday's figures may have some investors looking again at their own estimates for where rates are likely to end up. 

Below is a selection of remarks from various analysts and economists detailing how they interpret the numbers and detailing where either interest rates or the U.S. Dollar could go as a result. 

Ian Shepherdson, chief economist, Pantheon Macroeconomics 

"We were worried about a 0.5% core PCE deflator, but not 0.6%. The overshoot is concentrated in financial services, professional services, and healthcare, none of which are likely to persist. In professional services, for example, the 3.5% leap in tax preparation costs just reversed the unexpected drop in December."

"The Fed’s new obsession, core PCE services ex-energy, rose 0.58%, the biggest increase since November 2021.  Accordingly, we can’t rule out a return to 50bp, but it is not our base case: we expect the payroll, retail sales, and CPI numbers due before the FOMC meeting to assuage some of the market’s fears." 

"The core PCE deflator rose at a 4.1% annualized rate in the three months to January, compared to the previous three months, the slowest increase on this basis since November 2021. But service inflation is sticky, and a definitive downtrend is yet to begin."

James Knightley, chief U.S. economist, ING  

"The acceleration in the Federal Reserve’s favoured measure of inflation, the core personal consumer expenditure deflator, is a big story."

"This will ensure the Fed mantra of ongoing hikes continues with 25bp moves in March, May and June fully priced by markets. Talk of a potential 50bp move at the March Federal Open Market Committee meeting can’t be completely discounted, although we don't think they will carry through with it."

"Our caution centres on the combination of squeezed real incomes, rising interest rates and tightening lending conditions all happening at the same time. Household saving ratios are now well below pre-pandemic levels while the proportion of income spent on servicing the debts on consumer loans is at the highest since 2009." 

"This hints at financial pressures on the household sector and this will increasingly bite as we go through the year. It will only get worse if those lay-off announcements keep coming, which could lead to the economy to slow sharply in coming quarters, opening the door for a path to lower interest rates from the fourth quarter."

Jan Hatzius, chief economist, Goldman Sachs

"Our GS trimmed core PCE inflation measure increased 0.47% month-over-month in January and increased 4.02% from a year earlier. The consumption details were stronger than our previous assumptions and indicate upside to our Q1 forecasts. We will finalize our GDP tracking estimates after the mid-morning data."

Jonas Goltermann, deputy chief markets economist, Capital Economics

"Stronger-than-expected data out of the US have pushed up US yields more than elsewhere and drove the greenback higher against most currencies for the first time since its cyclical peak in October of last year."

"While US economic resilience may keep the greenbacks strong in the near term, we still think that recessions in most advanced economies and souring appetite for risk will ultimately be the factor that pushes the dollar back towards its cyclical high later this year." 

Alex Kuptsikevich, senior market analyst, FXPro

"In recent months US prices have been pushed up by an overheated labour market with the lowest unemployment rate since the late 1960s and a recovery in the services sector."

"The only way to beat this kind of inflation is to "cool the economy", which in the language of politicians and central bankers, means creating conditions where aggregate demand falls, i.e., job cuts in a hard-core scenario."

"As always in such circumstances, politicians talk about the intention to create a "soft landing", but such intentions have not been realised in the past, and the decline has, at some point, become uncontrollable."

Mike Owens, senior sales trader, Saxo UK 

"Fed swaps are now fully pricing in US rate increases in March, May and June. Two quarter of a percent rate increases are now also expected in the UK between now and Bank of England’s rate meeting in June."

"The UK 2yr yield reaches 3.96% and the German 2yr trades above 3% for the first time since 2008. Global stock markets fall around 1% with the US dollar strengthening against the pound and other major currencies.”