Friday’s US jobs figures may be the keynote US economic data release for traders this week but Thursday’s release of Personal Consumption Expenditure (PCE) data may prove to be of just as much interest to the Federal Reserve as it considers its next monetary policy moves.
The PCE numbers may also help shape the US dollar’s next trajectory.
Given that recent US Consumer Price Index (CPI) releases have hardly suggested US inflation is heading back towards the Fed’s 2 per cent target, the PCE reading may be even more important in shaping Fed policy intentions and market expectations. Market expectations about future US interest rate rises have already been somewhat pared back.
While the market took Yellen’s silence on US monetary policy direction as a negative for the US dollar, traders saw Draghi’s failure to address recent euro strength as a green light to buy the single currency
Policymakers and investors cannot also have failed to notice that although neither Fed Chair Janet Yellen nor European Central Bank (ECB) chief Mario Draghi alluded to tighter monetary policy last Friday at Jackson Hole, the currency markets nevertheless delivered a 0.8 per cent fall for the US dollar index on the day, pushing the euro to its highest level versus the greenback since January 2015.
While the market took Yellen’s silence on US monetary policy direction as a negative for the US dollar, traders saw Draghi’s failure to address recent euro strength as a green light to buy the single currency. From a behavioural standpoint, that might suggest a market that was anyway collectively looking for a reason to sell the US dollar.
The importance of PCE, and in particular core PCE data which excludes volatile food and energy prices, is not just academic speak, as can be seen in the Statement on Longer-Run Goals and Monetary Policy Strategy, most recently amended in January 2017, issued by the Fed’s rate setters, the Federal Open Market Committee (FOMC).
“The Committee re-affirms its judgement that inflation at the rate of 2 per cent, as measured by the annual change in the price index for Personal Consumption Expenditures, is most consistent over the longer run with the Federal Reserve’s statutory mandate,” the statement said.
But the problem for the FOMC, as it seeks reasons to justify tighter US monetary policy, is that not only has CPI data been pretty benign, posting a 1.7 per cent year-on-year rise in July compared to economists’ forecasts of a 1.8 per cent increase, core PCE has also not been showing signs of a pick-up. In fact the US core CPE year-on-year in June was only 1.5 per cent.
…the potentially disinflationary impact on US grocery prices of Amazon’s acquisition of Whole Foods, as well as the proposed expansion of discount chains such as Aldi and Lidl in the United States, isn’t easily ignored
Indeed Canada’s BMO Capital Markets feels that “the string of five consecutive misses on [US] core-CPI have surely scaled back expectations for PCE this week” and the Canadian firm is contemplating “the sticker shock of a 1.4 per cent (or below) core inflation print.”
Admittedly, this month’s Economic Letter from the Dallas Fed argues that “the earliest official PCE inflation estimates should not be taken at face value” and that “recent low inflation readings will likely be revised upward,” but markets react to the face value of data, especially when the FOMC has previously flagged that data’s importance.
And while the Fed might seek to look through movements in food prices, the potentially disinflationary impact on US grocery prices of Amazon’s acquisition of Whole Foods, as well as the proposed expansion of discount chains such as Germany’s Aldi and Lidl in the United States, isn’t easily ignored.
Both are known for low prices, with the former planning to spend US$3.4 billion over the next five years to open 900 supermarkets, the company said in June.
The currency markets will also be mindful of the impact of international interest rate differentials on the US dollar’s value.
A continuation of benign US PCE data should lead markets to push back expectations of US rate hikes yet further. That could leave the US dollar exposed when other central banks are edging towards or have begun tightening monetary policy and where there remains an absence of clarity on the timing of any implementation of President Trump’s election platform of economic stimulus.
The dollar/yuan exchange rate could be a case in point.
Last week the People’s Bank of China (PBOC) drain a net 330 billion yuan (US34.16 billion) ouf of the market, causing money market rates to spoke.
Such a policy is consistent with an attempt by the PBOC to force non-bank financial lenders, who often rely on short-term funding to finance their business model, to deleverage.
But the higher China’s short-term rates go and the longer they stay elevated, the more attractive the yuan may look in preference to the US dollar, especially if the market continues to pare back US rate hike expectations.
Investors should keep a close eye on this Thursday’s US PCE data. The Fed will.