Interest rates rocketed higher to start the week and the 10-year Treasury yield is now holding steady at just below 3%. The next jolt to the bond market though might come by the end of the week. This is because on Friday before market open, the Personal Consumption Expenditures (PCE) Index, the Federal Reserve’s preferred measure of inflation, will be published for the first quarter. If the number is higher than expected, interest rates could quickly break through the 3% mark.
Ever since Alan Greenspan chaired the Fed, the PCE has been the central bank’s preferred measure of inflation, despite the fact that it tends to get less attention than the more familiar Consumer Price Index (CPI).
While the CPI inflation rate has been above the Fed’s 2% target for five months now, this isn’t triggering any alarm bells at the Mariner Eccles Building yet because the PCE index is still lagging. The PCE annual inflation rate is still below 2% ever since 2012. Core PCE inflation is an even tamer measure that excludes volatile food and energy, and that measure has been consistently below 2% since before the financial crisis, with only two very brief breaks above it. In order to get the Fed to start reacting and raising rates more aggressively, the PCE price advance will probably have to go consistently above 2% on an annual basis.
As an aside, the quarterly PCE inflation rate, as opposed to annual, has already reached 2.7% as of last quarter, so the Fed is running low on plausible deniability of inflation already.
In any case, what can we expect from the PCE given the CPI? The main differences between the two inflation measures are as follows, though these are frequently adjusted from year to year, including seasonal adjustment calculations. Costs for shelter are currently weighted at 31% for the CPI and only 15% for the PCE. Transportation is also a heavier 17% of CPI but only 10% of PCE. The most significant difference though is medical care, which is weighted only 7% in the CPI and 20% in the PCE. Altogether, the three account for 55% of CPI and about 45% of PCE. Considering the numbers, how might the quarterly PCE measure fare come Friday?
According to the Bureau of Labor Statistics CPI release earlier this month, medical care accounted for the single highest March jump of 0.5% from the previous month. Shelter and transportation price gains came in second and fourth, respectively. Basically, the three big categories for both indexes are all moving higher, faster than the other relatively more minor categories. The quarterly PCE measure could end up being even higher than the 2.7% logged for fourth quarter and the plausible deniability of inflation that the Fed currently enjoys could shrink further.
The implications for interest rates are clear. If rates are headed higher now, without the Fed chasing inflation and the target rate not yet officially reached, rates could move higher even faster if the Fed is forced to act more quickly.