January PCE Data Should Point to Easing Annual Growth

• Fed Governor Waller endorsed January PCE growth of 0.3%.
• Such an outcome would drop annualized growth to 2.4%.
• That would mark the first PCE decline since September.

The Federal Reserve’s favorite inflation gauge will show growth is slowing…

This coming Friday brings the next important update regarding price pressures. The U.S. Bureau of Economic Analysis (“BEA”) releases personal consumption expenditures (“PCE”) data for January. We care about the update because our central bank uses this gauge when making monetary policy decisions.

You see the Fed feels PCE is a more complete inflation reading because it measures the total spending on goods and services consumed by individuals, including those bought on their behalf like health insurance. On the other hand, the U.S. Bureau of Labor Statistics’ consumer price index (“CPI”) focuses on out-of-pocket spending by urban consumers. As a result, the weightings within PCE tend to be less concentrated than CPI. That means PCE fluctuates less, driving the Fed’s preference.

Based on recent business surveys, growth in services prices keeps easing. The shift should have an outsized effect on PCE compared to CPI. And based on the numbers I looked at, the Fed’s preferred inflation gauge saw subdued growth in January. That will ease Wall Street’s concerns about tighter monetary policy from our central bank later this year. And it would support a steady rally in risk assets like stocks.

But don’t take my word for it, let’s look at what the data’s telling us…

Two weeks ago, the BLS released its consumer and producer price index data for January. Within those gauges are several readings we care about as it relates to PCE. According to the data, items like housing, recreation, and transportation rose. Yet others, like financial services and insurance, non-durable goods, and food & accommodation contracted.

Housing and medical expenses account for roughly 17% of the PCE index each while the other categories’ weightings range between 3 and 8%. I ran the BLS inputs against the relative PCE weightings. Based on the numbers, I saw little change for January.

So, let’s see what that means for the pace of annualized growth…

The above table details the pace of monthly PCE growth for the last year. Notice that the result in December was 0.3%. If the pace of growth for January were to hold steady with last month, that would mean another 0.3% increase. The change would mean headline annualized growth dropped to 2.4% through January compared to 2.6% in December. That would be the first decline in annualized PCE growth since inflation began to tick back up in October.

There’s an important shift taking place that we should be keeping an eye on. At the start of 2024, we experienced “hot” monthly PCE growth. January through April represents more than half of the 2.5% annualized number. So, anything in-line with last year’s result would mean the pace of growth should remain unchanged. But a weaker number compared to last year would indicate a slowdown.

To see what I mean, let’s look at the January 2024 number. It rose 0.4%. Now, if the result for January 2025 is 0.4%, then annualized PCE growth will remain at 2.5%. Yet if PCE were to hold steady with December, and rise 0.3%, that would mean we lose the higher number from the 12-month data, dropping annualized PCE to 2.4%.

Just last week, Federal Reserve Governor Christopher Waller said January PCE should come in around 0.3%. He also expects numbers to keep easing as the year progresses. And Chairman Jerome Powell has noted that the related CPI and PPI data point to stable PCE growth.

So, as I said at the start, when the January PCE numbers are released on Friday, they’re likely to show little change to the monthly pace of growth. Such an outcome will go against the consensus expectation for an inflation rebound. That could lead to a rethink of expectations for little if any interest rate cuts later this year. That change will allow the Fed to pursue a normalization of monetary policy, supporting steady economic growth and a long-term rally in the S&P 500 Index.

Five Stories Moving the Market:

Talks between the top appropriators in the House and Senate have soured in the past week, with lawmakers still searching for an agreement on topline spending levels that are a prerequisite for funding individual agencies and programs for the remainder of the fiscal year – Politico. (Why you should care – the lack of an agreement points to the potential for a government shutdown when the current budget agreement expires March 14)

The Christian Democratic Union’s Friedrich Merz is the clear winner of the German election; the question now for the conservative leader is how fast and with whom he can cobble together a government – WSJ. (Why you should care – while the outcome is within Wall Street’s range of expectations, the fragmented parliament representation is likely to encourage more growth-friendly legislation) ?

Federal Reserve Bank of Chicago President Austan Goolsbee downplayed the University of Michigan’s report on consumer expectations for future inflation; the policymaker said it “wasn’t a great number,” but a single month doesn’t make a trend – Bloomberg. (Why you should care – Friday’s rising stagflation fears may prove to be overblown)

America’s biggest employer, the federal government, is laying off workers in droves; yet based on the way the layoffs have been structured, and given the potential for new hires, the fallout may seem muted at best – WSJ. (Why you should care – based on those estimates, the layoffs are unlikely to have much impact on nonfarm payroll data)

U.S. business activity fell to a 17-month low in February, amid mounting fears over tariffs on imports and deep cuts in federal government spending; the services sector accounted for the drop in S&P Global’s Composite Purchasing Mangers’ Index, contracting for the first time since January 2023 – Reuters. (Why you should care – slowing services sector activity should help to place downward pressure on inflation growth)

Economic Calendar:

Earnings – DPZ, O

Germany – Ifo Business Expectations for February (4 a.m.)

Eurozone – CPI for January (5 a.m.)

BOE’s Ramsden (Deputy Governor) Speaks (8:15 a.m.)

BOC’s Gravelle (Deputy Governor) Speaks (8:15 a.m.)

U.S. – Chicago Fed National Activity Index for January (8:30 a.m.)

U.S. – Dallas Fed Manufacturing Survey for February (10:30 a.m.)

Treasury Auctions $76 Billion in 13-Week Bills (11:30 a.m.)

Treasury Auctions $68 Billion in 26-Week Bills (11:30 a.m.)

Treasury Auctions $69 Billion in 2-Year Notes (1 p.m.)

BOE’s Dhingra (Board Member) Speaks (1 p.m.)