Breaking News: PCE Price Index Declines Adding Further Pressure on the US Dollar
USD Breaking News: PCE Price Index Declines Adding Further Pressure on the US Dollar
The USD rallied to record highs last year and it appears to have hit a ceiling. The Federal Reserve may pause, but it won’t drive the dollar significantly lower, says J.P. Morgan’s Meera Chandan. She argues that a pause is not enough to derail the dollar’s strength against the euro, British pound and Japanese yen, but it does make the U.S. more vulnerable to recessions in the coming years.
Goods Inflation Slowed a Little and PCE Inflation Slowed More
Overall inflation in the US has been slowing since the start of 2021 as goods prices have cooled a bit in response to weaker demand and supply chain improvements. As a result, the core PCE inflation measure has declined by more than one percentage point in the past six months and is now expected to have fallen back below 2 percent in November, according to Reuters.
Decelerating goods inflation is largely due to declining demand for durable goods, as consumers are holding on to their spending as they wait for the economy to grow faster. However, it’s important to note that decelerating goods inflation doesn’t automatically mean that overall inflation will return to the Fed’s favored 2 percent level.
Services Inflation is Rising As a Slow Pass-through of Surging House Prices to Rent and OER
The rising price of rent has added 1.4 percentage points to the core PCE inflation series in July, reflecting the slow pass-through of surging house prices. This is likely to continue in the coming months, as a recent Dallas Fed analysis suggests that rent and owners’ equivalent rent (OER) will add another 35 basis points to headline PCE inflation in the coming months before easing in mid-2023.
Inflation in health care is also likely to rise in the coming months, as wages for hospital workers have risen sharply over the past year. These factors will likely add upward pressure on the PCE health care component of the PCE price index, which has a disproportionate weight in the PCE measure.
USD & EUR/USD Outlook for 2023: Strong Dollar Will Inflect Higher
The United States’ currency strengthened in a record-breaking year as the Fed hiked interest rates aggressively and governments and central banks around the world conducted rate hikes and foreign exchange interventions to boost their currencies relative to the dollar. The dollar is still expected to inflect higher versus the euro, British pound and Japanese Yen in 2023, according to J.P. Morgan’s Benjamin Shatil and Meera Chandan, who note that a pause in the Fed’s monetary tightening is not sufficient to push the USD down if the underlying macroeconomic backdrop remains supportive.
Despite the slowdown in the US economy, the Fed remains committed to taming inflation and has indicated it is ready to raise interest rates again in the near future. As a result, the US Dollar has been strong and US Treasury yields have surged in the last few weeks as traders expect the Fed to raise interest rates by 25 basis points in December and at least two more times this year. In addition, the European Central Bank has signaled its commitment to raise its key interest rate by at least half a percentage point this month, boosting the EUR/USD pair.