Fed’s Key Inflation Rate Cooled In February; S&P 500 Rises

The Federal Reserve’s key inflation rate showed price pressures were tamer than expected in February, as consumer spending softened. After the report, the S&P 500 futures opened moderately higher.

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Perhaps the best news in the report was that inflation in services prices outside of housing also cooled down after running hot in recent months.

Yet with inflation still far above the Fed’s comfort zone, it could take an abrupt rise in jobless claims or more evidence of bank fragility to avoid one further rate hike on May 3.

PCE Inflation Rate Hits And Misses

The overall personal consumption expenditures, or PCE, price index rose 0.3% on the month and 5% from a year ago, easing from a downwardly revised 5.3% in January. Wall Street had expected a 0.4% monthly rise. The 12-month PCE inflation rate was expected to ease to 5.1%.

Core PCE inflation, which strips out volatile food and inflation prices, also rose 0.3% on the month vs. forecasts of 0.4%. The core inflation rate slipped to 4.6%, below forecasts of a steady 4.7%.

Personal spending rose 0.2% in February after January’s upwardly revised 2% jump. Adjusted for price increases, goods spending and services spending both dipped 0.1%.

Core PCE Services Inflation

The Fed typically emphasizes the core PCE inflation rate. Yet with goods-price pressures abating, as demand and supply chains normalize,  and housing costs expected to follow later this year, Fed chair Jerome Powell has honed in on core nonhousing services prices as the key to the inflation outlook. That’s because prices of services from haircuts to health care to hospitality are closely linked to wages, generally the biggest cost input.

In February, core PCE services prices ex-housing rose 0.3% on the month, down from 0.5% in January and the smallest increase since July. That left the annual inflation rate for core nonhousing services at 4.6%.

Health care prices rose a tame 0.2% and education 0.1%, while air transportation costs fell 0.7% on the month. Still, wage pressures are putting upward pressure on personal care services (up 0.8%), food services (0.5%) and recreation services (0.9%).

Fed Rate Hike Outlook

Still, the softer inflation readings didn’t immediately have much impact on the outlook for a Fed rate hike on May 3. Markets are now pricing in 48% odds of a quarter-point hike, little changed from 47% on Thursday.

Meanwhile, the 2-year Treasury yield rose 2 basis points to 4.12%.

S&P 500 Reaction

After the inflation report, the S&P 500 opened about 0.3% higher in early Friday stock market action. On Thursday, the S&P 500 rose 0.6% to reach its highest level since March 6, just before the bank crisis began to snowball with the abrupt failure of SVB Financial Group.

The S&P 500 closed 13.25% above its Oct. 12 bear market low but remains 15.55% below its all-time high.

The recent rally has been led by tech, particularly big tech stocks, amid the outlook for fewer Fed rate hikes due to bank-sector stress. The Fed expects tighter bank credit to slow the economy, so rates won’t have to rise as far to bring down inflation. Still, inflation has a long way to fall, so the Fed expects a brush with recession, if not an actual recession, which could hurt S&P 500 earnings.

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