Just a day before the Fed starts its two-day monetary policy meeting, the Bureau of Economic analysis will release figures on the core personal consumption expenditure price index (PCE), the Fed’s most preferred inflation measure. However, the results are less likely to drive to a rate hike on Wednesday as markets are already pricing in a ‘no-change’ rate decision. Still, any upside surprise in the data might generate hawkish feelings about the central bank’s appetite for tighter monetary policy before Jerome Powell replaces Janet Yellen as the new Fed chair in February.
On Monday at 1330 GMT, the US PCE inflation, which excludes food and energy is expected to stand pat at 1.5% y/y in December, finishing 2017 below the Fed’s target of 2.0%, while on a monthly basis the gauge’s change is said to inch up by 0.1 percentage points to 0.2%. Economists are challenged to explain the lack of inflation, as many of them are surprised to see the famous Philips curve, which presents the inverse relationship between inflation and unemployment rate, not holding in times when the central bank was using artificial ways to spread money to the markets. The nationwide unemployment rate hit a 17-year low of 4.1% in December, whereas in several states the jobless rate dropped to historically low levels. On the other side, inflation did not go in the direction predicted but instead eased from 1.8% in the beginning of 2017 to 1.5% y/y in the aforementioned month, with the Fed chair Janet Yellen characterizing the phenomenon a ‘mystery’. That also brought doubts whether the gloomy inflation was indeed only transitory. Even so, policymakers remained optimistic that a strengthening labor market will push wage growth higher and eventually drive inflation towards the target probably by the end of this year.
On Friday, the Commerce Department showed that the US economy expanded by 2.6% y/y in initial estimates in the fourth quarter of 2017, failing to meet the 3.0% forecast and falling below the previous print of 3.2% as the trade deficit widened to its biggest since 2008. However, the parts of the report that mattered most for demand came in stronger than expected, pointing that price growth might gain momentum in 2018. Consumer spending turned the strongest in three years, rising by 3.8% y/y, while a measure of core inflation related to consumer spending hit the highest level in a year, jumping by 0.6 percentage points to 1.9% y/y. Hence, today’s readings on personal spending and personal income might also shed light to whether consumption forces have the strength to add speed to the slow-moving inflation and consequently help the Fed to stay on course with its stimulus reduction plans. Still, the market is currently betting that the central bank will hold rates unchanged at the end of its two-day meeting on Wednesday, probably signaling that a rate rise might only come in March.
Turning to forex markets, dollar/yen had its worst start of the year since 2003 last week, breaching the 200-day moving average and making a deep move downwards to the 108 key area. This week, data out of the US will dominate the calendar, with the PCE index being the first to test the greenback’s downside. A disappointing outcome would add further losses to dollar/yen, which could try to find a bottom at 108 psychological level. Any decreases from here would also shift focus to 107.31 critical handle, which if violated would turn the medium-term outlook from neutral to bearish. Alternatively, encouraging results would drive the market back to the 109 key mark, while larger deviations from forecasts would likely retest the area between 110 and 111.
, the Fed’s most preferred inflation measure. However, the results are less likely to drive to a rate hike on Wednesday as markets are already pricing in a 'no-change' rate decision. Still, any upside surprise in the data might generate hawkish feelings about the central bank’s appetite for tighter monetary policy before Jerome Powell replaces Janet Yellen as the new Fed chair in February. ){kind=link}