US core PCE set to show inflation under control as markets are unclear about further Federal Reserve rate cut
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- The core Personal Consumption Expenditures Price Index is expected to rise 0.3% MoM and 2.8% YoY in October.
- Markets are undecided on whether the Fed will lower the policy rate by 25 basis points at the next policy meeting.
- Annual PCE inflation is forecast to edge higher to 2.3% from 2.1% in October.
The United States Bureau of Economic Analysis (BEA) is set to release the Personal Consumption Expenditures (PCE) Price Index data for October on Wednesday at 15:00 GMT. This index is the Federal Reserve’s preferred measure of inflation.
Although PCE inflation data is usually seen as a big market-mover, this time it might be difficult to assess its impact on the US Dollar’s (USD) valuation. With the US entering the Thanksgiving holiday on Thursday, other macroeconomic data –such as the weekly Initial Jobless Claims, October Durable Goods Orders and the second estimate of the third-quarter Gross Domestic Product (GDP)– will be released alongside the PCE inflation figures.
Anticipating the PCE: Insights into the Federal Reserve's key inflation metric
The core PCE Price Index, which excludes volatile food and energy prices, is projected to rise 0.3% on a monthly basis in October, matching September’s increase. Over the last twelve months, the core PCE inflation is expected to edge higher to 2.8% from 2.7%. Meanwhile, the headline annual PCE inflation is seen rising to 2.3% from 2.1% in the same period.
At the November policy meeting, the Federal Reserve (Fed) decided to lower the policy rate by 25 basis points (bps) to the range of 4.5%-4.75%. In the policy statement, the US central bank made a small adjustment to say inflation "made progress" towards the Fed’s target, compared to “made further progress” in the previous statement. Additionally, the Fed noted that the core PCE inflation has shown little change over the past three months.
Previewing the PCE inflation report, TD Securities said: “Headline PCE prices likely rose at a firm 0.27% m/m pace, with core rising 0.31% m/m and supercore inflation accelerating to 0.39% m/m.”. “Separately, we look for consumer spending to start Q4 with a soft tone, rising 0.3% m/m in nominal terms in October and close to flat in real terms,” added TD Securities in a recently published report.
The CME Group FedWatch Tool shows that markets are currently pricing in a nearly 41% probability of the Fed holding the policy rate unchanged at the last policy meeting of the year, suggesting that the US Dollar is facing a two-way risk heading into the event.
Interest rates FAQs
Interest rates are charged by financial institutions on loans to borrowers and are paid as interest to savers and depositors. They are influenced by base lending rates, which are set by central banks in response to changes in the economy. Central banks normally have a mandate to ensure price stability, which in most cases means targeting a core inflation rate of around 2%. If inflation falls below target the central bank may cut base lending rates, with a view to stimulating lending and boosting the economy. If inflation rises substantially above 2% it normally results in the central bank raising base lending rates in an attempt to lower inflation.
Higher interest rates generally help strengthen a country’s currency as they make it a more attractive place for global investors to park their money.
Higher interest rates overall weigh on the price of Gold because they increase the opportunity cost of holding Gold instead of investing in an interest-bearing asset or placing cash in the bank. If interest rates are high that usually pushes up the price of the US Dollar (USD), and since Gold is priced in Dollars, this has the effect of lowering the price of Gold.
The Fed funds rate is the overnight rate at which US banks lend to each other. It is the oft-quoted headline rate set by the Federal Reserve at its FOMC meetings. It is set as a range, for example 4.75%-5.00%, though the upper limit (in that case 5.00%) is the quoted figure. Market expectations for future Fed funds rate are tracked by the CME FedWatch tool, which shapes how many financial markets behave in anticipation of future Federal Reserve monetary policy decisions.
How will the Personal Consumption Expenditures Price Index affect EUR/USD?
Market participants could scale back bets on a December rate cut in case the monthly core PCE Price Index rises at a stronger pace than expected. In this scenario, the USD could gather strength and make it difficult for EUR/USD to hold its ground. Conversely, a monthly core PCE Price Index increase of 0.2% or lower could revive optimism about further progress in disinflation and weigh on the USD with the immediate reaction, opening the door for a rebound in the pair in the near term.
Eren Sengezer, European Session Lead Analyst at FXStreet, shares a brief technical outlook for EUR/USD:
“The Relative Strength Index (RSI) indicator on the daily chart remains well below 50, while holding above 30, suggesting that EUR/USD has more room on the downside before turning technically oversold.”
“On the downside, 1.0400 (static level) aligns as first support. In case EUR/USD makes a daily close below this level and starts using it as resistance, 1.0330 (November 22 low) could act as interim support before 1.0230 (static level from November 2022). Looking north, the first resistance could be spotted at 1.0600 (static level) ahead of 1.0660 (20-day Simple Moving Average). If EUR/USD clears that latter hurdle, it could target 1.0800 (static level) next.”
US Dollar FAQs
The US Dollar (USD) is the official currency of the United States of America, and the ‘de facto’ currency of a significant number of other countries where it is found in circulation alongside local notes. It is the most heavily traded currency in the world, accounting for over 88% of all global foreign exchange turnover, or an average of $6.6 trillion in transactions per day, according to data from 2022. Following the second world war, the USD took over from the British Pound as the world’s reserve currency. For most of its history, the US Dollar was backed by Gold, until the Bretton Woods Agreement in 1971 when the Gold Standard went away.
The most important single factor impacting on the value of the US Dollar is monetary policy, which is shaped by the Federal Reserve (Fed). The Fed has two mandates: to achieve price stability (control inflation) and foster full employment. Its primary tool to achieve these two goals is by adjusting interest rates. When prices are rising too quickly and inflation is above the Fed’s 2% target, the Fed will raise rates, which helps the USD value. When inflation falls below 2% or the Unemployment Rate is too high, the Fed may lower interest rates, which weighs on the Greenback.
In extreme situations, the Federal Reserve can also print more Dollars and enact quantitative easing (QE). QE is the process by which the Fed substantially increases the flow of credit in a stuck financial system. It is a non-standard policy measure used when credit has dried up because banks will not lend to each other (out of the fear of counterparty default). It is a last resort when simply lowering interest rates is unlikely to achieve the necessary result. It was the Fed’s weapon of choice to combat the credit crunch that occurred during the Great Financial Crisis in 2008. It involves the Fed printing more Dollars and using them to buy US government bonds predominantly from financial institutions. QE usually leads to a weaker US Dollar.
Quantitative tightening (QT) is the reverse process whereby the Federal Reserve stops buying bonds from financial institutions and does not reinvest the principal from the bonds it holds maturing in new purchases. It is usually positive for the US Dollar.
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