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PCE on Earth. Goods Still. Amen

The War on Inflation Is Won Just in Time for the Holidays

Trierer Weinachstmarkt

Fitting, perhaps, for the day after the longest night of the year, the Personal Consumption Expenditures price index, produced by the Bureau of Economic Analysis and the Federal Reserve's preferred measure of price change, showed a year-on-year increase of 2.6%. The high-flying PCE index has touched down.

The same measure, but excluding volatile food and energy prices, showed an increase of 3.2%.

When we further exclude housing, we can see that the inflation rate is below 3%. More work needs to be done to bring the cost of shelter down.

The $46.7 billion increase in current-dollar PCE in November reflected an increase of $58.8 billion in spending for services and a decrease of $12.1 billion in spending for goods.

The United States' experience with high inflation is at an end. Prices will continue to rise, as usual and is healthy for an economy, and prices may even spike again. But the period of price increases that erode the buying power of workers' wages is over. In the era of inflation targeting, 2% is the annual rise the world's central banks target, however central banks recognize that prices may over- or under-shoot that target. So, while the inflation rate still exceeds that 2% target, inflation is in the right neighborhood. The prices of Services continue to rise at above-target rates, but goods prices were still.

The initial reaction to the BEA's release was muted, which suggests that the market had already priced in lower inflation. It had come to expect this same outcome, and so when it was confirmed in its expectation, the response was modest delight. As everyone knows, the joy in opening Christmas presents is in the anticipation. GDP growth from the 3rd quarter of 2023 was revised down to 4.9%, which is not meaningfully less than the 5.2% that it had recently been revised to. Current GDP growth is still quite good at 2.2 - 2.7%.

The data print confirms what we learned from the CPI last week: watch for falling prices. The Federal Reserve's interest rate policy has been effective at tightening financial conditions to produce lower price inflation. Now that inflation is falling, the Fed must be cautious not to keep conditions so tight that they produce recessionary conditions. The Board of Governors has already begun discussing when they will lower interest rates, but we do not yet know when they will begin to communicate this to the markets. There's a history of camel-humped inflation recoveries--where, after first rising, inflation falls, then rises again, and then falls again--. We may yet see this unwelcome ungulate grace our nativity scene. For this reason, the Fed will try to keep a straight face as it tries to hide a grin at having pulled off the soft landing it had hoped for.

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