Hot PCE Inflation Has Yields Pushing Higher

  • Treasury yields are taking it on the chin this morning after hotter-than-expected inflation numbers from the Personal Income and Spending Report for January (more on that below). The market was expecting a strong read on inflation, but the broad-based nature of the pricing strength still surprised and will certainly up the hawkish talk, if that is possible, at the Fed. Currently, the 10yr is yielding 3.94% and the 2yr is at 4.80%.


  • With a strong CPI report already in hand, the market was bracing for stronger-than-expected inflation numbers in the January Personal Income and Spending Report, and it did not disappoint in that regard. Forecasts were calling for a rebound of sorts in all the metrics, from income to spending to inflation and except for incomes the report exceeded those estimates adding pressure on yields and certainly bolstering the Fed’s hawkish higher-for-longer stance.


  • First, to the inflation numbers. The overall PCE deflator rose 0.6% MoM vs. 0.5% expected and 0.2% in December (revised up from 0.1%). That’s the highest monthly rate since June and it pushed the YoY rate to 5.4% vs. 5.0% expected and an upwardly revised 5.3% in December (originally 5.0%). A year ago, YoY PCE was 6.0% so there is improvement but it’s most definitely of the grudging variety.


  • Meanwhile, Core PCE rose 0.6% vs. 0.4% expected and 0.4% in December. That was also the highest MoM rate since June and sent the YoY from an upwardly adjusted 4.6% to 4.7% vs. 4.3% expected. Further compounding Fed worries is that the services-side showed no signs of slowing in this report. Powell and company have recently drawn more attention to the fact they are focusing more on the services-side inflation picture, ex-housing, and this report will confirm they are right to focus on that (see graph below).


  • While we had the hot retail sales report already in hand,  the beat in spending in this report was still somewhat surprising. Spending rose 1.8% MoM vs 1.4% expected and was the largest monthly gain since March 2021. The impressive thing about the spending was the broad-based nature of it. Both the goods-side and services side showed healthy gains across many categories. This report carries more services spending categories than retail sales, and while it showed service spending continues to gain, it also showed the consumer renewed his/her love affair with durable goods spending as well. Adjusting for inflation real spending rose 1.1%, the highest since March 2021. Clearly, the consumer is not going down quietly.


  • Personal income was the one area that may have superficially disappointed with the MoM at 0.6% vs 1.0% expected and 0.3% in December, but there is more to that headline than meets the eye. Wage and Salary compensation rose 0.9%, the largest gain since July. Incomes were also helped by a 9% increase in social security payments as the 8.7% COLA adjustment hit retiree accounts. The overall income number, however, was held down by a large negative result for a transfer program literally labeled “Other”  in the table and that’s why the savings rate rose from 4.5% to 4.7%. So, all-in-all, it was a solid month of income gains for consumers and that will embolden the Fed as well.


  • There is some talk that the large upward revisions to the PCE index’s historical year-over-year path reflect data that incorporate upward revisions to Q4 but not downward revisions to Q3 or earlier periods. That could mean the 12-month changes might be overstated.


  • That’s a take that won’t probably figure in today’s trading on the headline numbers, but it does add to the thought that plenty of January reports contain a fair amount of noise, so it may pay to wait for February results to either confirm January strength, or perhaps cast them in a less robust light. For now, the market is taking the bait and expecting rate hikes to move up to 5.5% by mid-year.

Core PCE Inflation Ex- Housing


    Agency Indications — FNMA / FHLMC Callable Rates

    Maturity (yrs) 2 Year 3 Year 4 Year 5 Year 10 Year 15 Year
    0.25 5.59 5.36 5.29 5.28 5.27 5.73
    0.50 5.58 5.33 5.23 5.17 5.13 5.62
    1.00 5.57 5.30 5.20 5.12 5.04 5.49
    2.00 5.29 5.14 5.04 4.92 NA
    3.00 5.00 4.86 NA
    4.00 4.81 NA
    5.00 4.78 NA
    10.00 NA

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Published: 02/24/23 Author: Thomas R. Fitzgerald