The Fed's Favored Measure Of Inflation On Tap: "The PCE Deflator"


Unless you were out caving, like Lando Norris was and missed out on when the Lewis Hamilton to Ferrari news broke, you likely heard that Equities hit fresh record highs last week in several markets from Europe to Japan. In North America, the rally was fuelled by a stellar earnings report by Nvidia on Wednesday, which sparked broader exuberance on AI's benefits and resulted in the largest single-day value creation event in US stock-market history.

In classic melt-up fashion, a stampede of investors has been gobbling up virtually every investible asset with some attachment to Nvidia, leaving bewildered bears in the wake.

While one might have anticipated some profit-taking on Friday, and it may very well occur to some extent this week ahead of the PCE, with call skew experiencing a crazy surge in demand as investors seek upside protection, it suggests that investors of all stripes could be coming around the idea that Nvidia is not a bubble. Indeed, we are only at the start of the runway, so it's conceivable that the AI plane has not yet taken full flight.

Financial markets have adjusted their rates expectations, now pricing 75-100 basis points of Federal Reserve interest rate cuts for the year, a notable shift from the 150-175 basis points favoured just a few weeks ago. Risk-sensitive assets typically experience downward moves when rate cut expectations fizzle; however, in the equity markets, the prevailing narrative is outperformance driven by the technology sector, overruling normal market dynamics.

All the talk is about the PCE this week, but with January's Producer Price Index (PPI) and Consumer Price Index (CPI) reports suggesting outsized increases in critical components of the PCE deflator, the market is already braced for an uptick with the consensus forming around .4 % month on month increase. And it certainly won’t sit well with the Feds, who need to see more month-on-month prints below 0.2% to convince them that inflation is confidently returning to the 2% year-on-year target before entertaining rate cuts.

Still, we are of the view that policymakers and investors could look through the January increase. Temporary factors, including residual seasonality and the increase in portfolio-management service prices, are critical drivers behind the January increase. Similarly, some of the expected gains in personal income come from cost-of-living adjustments and an unsustainably high nonfarm payroll print.

Even if prices exhibit a 0.3% to 0.4% rise in January, the yearly rate could decrease slightly due to a favourable comparison with the previous year. Consequently, the gap between core inflation measures may widen to 1.2 percentage points, marking the most significant disparity over 22 years and three times the long-run median since 1960. Indeed, the muddled macro environment continues, and we completely understand the Fed’s frustrations.

That said, we think the impact of Nvidia wanes slightly this week on the build-up of the PCE, creating a few opportunities to score some reversion points on risk betas.


Global investor risk sentiment has improved at the start of this year, reflecting growing optimism about a softer landing for the global economy. Furthermore, evidence suggests that the emergence of AI is bolstering corporate revenues and ultimately enhancing productivity. This trend underscores the increasing confidence among investors regarding the resilience and adaptability of businesses in the face of economic challenges.

USD/JPY has returned to the "intervention zone," if not for that, it is conceivable we would be trading on 152's

The prevailing global risk-on conditions and the new record high in Japanese equities have likely bolstered the Bank of Japan's (BoJ) confidence in achieving price stability. Governor Ueda's recent remarks in the Diet reflect a more optimistic and assertive tone, suggesting increasing confidence within the BoJ regarding the prospects of fostering higher wages and inflation.

Economists are considering the possibility of a rate hike by the BoJ in April. However, a hike could take place as early as March, which may be underestimated by the markets at present. The current movements in USD/JPY are dominated by the changes in the 2-year and 10-year US Treasury yields. The latter has historically shown a strong correlation. Still, if traders pick up on any indications of a potential rate hike by the BoJ in March, it may cause a reversal in USD/JPY, pushing the pair back towards the 142 level.


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