The question on everyone’s mind today is: Why is the bond market rallying so hard?
US 2-year yields are down 11 bps and Fed funds now price in 164 basis points of cuts.
US 2 year yields daily
One answer may be that indications for the Fed’s preferred measure of inflation — the PCE report — are falling. Economists are extrapolating the details from CPI and PPI and transposing them to PCE. The result is a number that’s below the key psychological 3% y/y level.
“Based on details in the PPI and CPI reports, we estimate that the core PCE price index rose 0.17% in December, corresponding to a year-over-year rate of +2.93%,” writes Goldman Sachs today.
Similarly, Renaissance Macro writes:
The message from PPI is that core PCE will not come in nearly as firm as core CPI did. Using the inputs from CPI/PPI, we estimate core PCE of 0.2% MoM. Over the last 12 months, it is core PCE inflation is likely to come in below 3.0%.
They note that healthcare inflation measurements diverge in the two series.
Healthcare services inflation is not running nearly as strong in PCE as it has been in CPI. There are differences of scope between the two series. This is an important reason why there is a growing gap between these two measures of inflation
The PCE report isn’t due until January 26 but it will be a critical input for the FOMC, which meets Jan 30-31.