Signs of stickier inflation, strong economic data, and more hawkish signals from Fed officials threw a bucket of cold water on market sentiment this week.
Recognising that the Fed might still have more work to do to bring down inflation, markets have adjusted their expectations for how high US interest rates could go. Now, predictions are for the Fed to hike its benchmark rate two to three more times this year from its current range of 4.5%-4.75%.
While this brings the market closer to the central bank’s latest projections in December, investors and the markets are still disconnected: the Fed has signalled that rate cuts are unlikely this year, but markets still see some scope for easing toward the end of 2023.
What does this difference in expectations mean?
Bond yields rose and stock markets sold off this week as markets digested the prospect that interest rates could stay higher for longer. So, we could see further market volatility if the Fed continues to take a more hawkish stance than markets expect.
❗Spoiler alert: We explore this topic further in our upcoming CIO insights - so stay tuned!
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Personal Consumption Expenditures (PCE) is a measure of how much US households spend on goods and services. Consumer spending is an important part of US GDP, and economists use information on consumers’ buying habits to make projections about future economic growth.
The PCE price index reflects changes in the prices of these goods and services, and the Fed uses it to gauge inflation in the US.
The Fed prefers the PCE price index to the CPI (or consumer price index) because:
The PCE is a broader measure of inflation. It takes into account both urban and rural consumers, while CPI measures prices for urban consumers.
The PCE better accounts for changing consumer preferences or substitutions. For example, consumers might choose to buy apples if the price of oranges increases.
That said, the CPI and PCE have historically shown similar inflation figures. And given that the CPI is released a couple of weeks earlier than the PCE each month, the CPI is the index that tends to have a bigger impact on financial markets.
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