Key Metric Hits Fed’s 2% Target, Bolstering Case for Rate Cuts in 2024
The latest inflation data released on Friday provides the most convincing evidence yet that the Federal Reserve is finally getting prices under control after a year-long battle against rampant inflation.
The personal consumption expenditures (PCE) price index, the Fed’s preferred inflation gauge, fell 0.1% from October and rose 5.5% over the past year. But the more closely watched core rate, which excludes volatile food and energy costs, rose just 0.2% from October and 4.4% over the last 12 months – dropping below the Fed’s target of 2% to 1.9% for the first time since April 2021.
This marks the sixth straight monthly decline in year-over-year PCE inflation from June’s four-decade high of 7.3%, validating the Fed’s aggressive interest rate hikes. The latest numbers will likely bolster the case for rate cuts in 2024 to sustain the economic recovery.
“Promising signs for 2024 were abundant in Friday’s inflation report – the last such readout for 2023,” said senior White House economist Jared Bernstein. “The main takeaway is that the disinflationary process is well underway.”
Fed’s Rate Hikes Paying Off as Inflation Approaches Target
The better-than-expected inflation figures suggest the Fed’s campaign of supersized rate hikes is finally succeeding in cooling the economy and taming the price spikes.
Core PCE has eased substantially from its peak of 5.3% in February 2022, nearing the Fed’s 2% goal. The overall PCE index also fell from its recent high of 7.3% in June to 5.5% currently.
“Inflation is getting close to the Federal Reserve’s target rate of 2%,” said Vice Chair Lael Brainard on Friday. She indicated further disinflation is expected next year amid slowing demand, reversing some of the Fed’s rate hikes.
Table 1. PCE Inflation Over Past Year
|June 2022 Peak
|Fed Target Rate
With price stability in sight, policymakers look increasingly willing to stop raising interest rates soon and eventually start cutting again to support growth – a pivot investors have awaited.
“The data dependent Fed has gotten an early holiday present with this read,” said Pimco economist Joachim Fels, forecasting rates peaking below 5% in 2023.
Outlook Improves for Soft Landing in 2024
The declining inflationary pressures raise hopes that the Fed can achieve a soft landing – cooling inflation toward its 2% goal without severely damaging the economy.
This Goldilocks scenario would see inflation and consumer spending moderate while job growth continues, avoiding recession. Such an outcome appears more plausible based on the encouraging data.
“Today’s inflation data leaves room for optimism that the Fed will be able to negotiate a soft landing for the economy,” said Obama economist Jason Furman.
Research firm Capital Economics predicts core PCE inflation will slide to just 2.3% by the end of 2023. Meanwhile, robust wage gains and solid spending should support ongoing growth.
“The economy is on the verge of a major turnaround heading into 2024,” said economist Bernard Baumohl. “Economists are now ratcheting up forecasts for GDP growth based primarily on the easing of inflation.”
Slower Inflation to Aid Consumer Spending Next Year
The cooling in inflation will help restore consumers’ purchasing power that was eroded for much of 2022. This could set the stage for stronger spending in 2024 as prices stabilize.
Personal incomes rose 0.6% in November, supporting further gains in consumer outlays which climbed 0.8% last month – doubling expectations. Such resilient spending amid slowing inflation points to a rebound in real incomes next year.
This aligns with research indicating nearly 60% of U.S. consumers are now better off financially than a year ago despite elevated inflation, according to Impact Genome and The Harris Poll.
With inflation-adjusted wages rising at the fastest pace in decades, there are signs everyday Americans will have more money to sustain economic momentum into 2024 as the inflation scare fades.
Lingering Risks Remain Despite Progress
While the favorable inflation figures mark a tentative victory for the Fed, officials caution the battle is not yet over. Further data will be needed to confirm the disinflationary trend is sustainable after just a one-month dip.
“There were promising signs, but we’re going to need to see more evidence,” said Fed Governor Michelle Bowman on Friday.
Another big risk is that still-tight labor markets could reignite inflation if wages spiral higher. The unemployment rate remains near 50-year lows at 3.7% in November.
And while goods inflation has moderated amid improving supply chains, the jury is still out on whether slowing demand alone can bring inflation down toward the 2% target.
For now, the Fed looks on course to further downshift the pace of rate hikes at its next meeting in February. But additional increases could still occur later in 2023 if price pressures pick up again.
“We may very well get to a point where we don’t have to do any more increases,” said Governor Christopher Waller recently. “But we’re not there yet.”
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