Today the Fed's favorite inflation gauge, the PCE (Personal Consumption Expenditures price index), came out below forecasts, and the market is buzzing.
Stocks and crypto are both climbing, though we'll need more time to know exactly why.
Still, the numbers themselves are confirmed. So let's see what they mean for the Fed's next rate decision, with some history along the way.
✦ The short version
Three points before we dive in
| 1 | Inflation came in cooler than forecast: 3.4% vs. 3.7% overall and 3.0% vs. 3.3% for core. |
| 2 | The Fed hiked in September, and 16 of 18 officials still expect one more hike this year, so a pause isn't guaranteed. |
| 3 | Next checkpoints: the jobs report on Oct 2 and the Fed meeting on Oct 27-28. |
✦ Inflation: forecast vs. actual
US, August, year over year
Let's start with the numbers. The US Commerce Department released August PCE on September 30, and it rose 3.4% from a year earlier. Economists had expected 3.7%.
Core PCE, which strips out food and energy, came in at 3.0% against a forecast of 3.3%. The dollar index also fell 0.3% to about 101 right after the release.
Don't relax yet, though. Even this reading is still far from the 2% inflation rate the Fed targets.
US media described it as lower than expected but still well above the target.
✦ Where the Fed stands right now
As of the September 16 decision
| 3.75-4.00% | Policy rate after a 0.25-point hike, the first since 2023 |
| 12-0 | A unanimous vote for the hike |
| 16 of 18 | Officials expecting one more hike this year |
| Oct 27-28 | The next meeting |
So where does the Fed stand? On September 16 it voted 12-0 to raise rates by 0.25 percentage points to 3.75%-4.00%.
That was the first hike since 2023. Chair Kevin Warsh said inflation is too high and has been for too long.
The committee's outlook was hawkish too. Sixteen of 18 officials expect one more hike this year, and the median year-end rate was 4.1%.
But another hike isn't guaranteed. New York Fed President John Williams said that after September's move there's no urgency, and there's time to gather more information.
Governor Michael Barr, on the other hand, said further adjustments are likely needed to bring inflation down to target. So even inside the Fed, the temperature differs.
That's why the odds of an October hike have swung wildly. On CME's FedWatch tool they bounced between the 70% range and around 50% within a week.
One report put them above 70% just before the release. Where they go after today's data isn't confirmed yet. The next meeting is October 27-28.
✦ How one inflation number moves stocks and bitcoin
What usually happens when inflation comes in low
| Inflation comes in lower than expected, so the Fed has less reason to hike | |
| Stocks | Bitcoin |
| Bond yields ease, so companies' future profits are discounted less and stock prices rise | Savings and bond yields rise less, so bitcoin, which pays no interest, looks better and its price rises |
Why do stocks and crypto move together on one inflation number? When rates rise, the present value of what companies will earn in the future shrinks, so stocks, especially growth stocks, wobble.
Bitcoin pays no interest, so many people think it loses appeal as safe deposits and bonds pay more.
So when inflation comes in low and rate-hike expectations fade, stock and bitcoin prices often rise together. Bitcoin's recent stall in a narrow range around $83,000 was also blamed on high long-term yields.
✦ Four chapters in the history of rate hikes
In chronological order, with the lesson of each
| 1970s to 1980 | Inflation topped 14%, the policy rate went to around 20%. Ease off tightening too early and you pay more later. |
| 1994 | Rates doubled from 3% to 6% in about a year; Orange County went bankrupt. Hike faster than markets expect and something breaks. |
| 2004 to 2006 | 17 straight hikes, yet long-term yields stayed low: the "conundrum." Today it's the opposite: long-term yields rise first. |
| 2022 to 2023 | Eleven hikes to 5.25%-5.50%. Hikes resumed this September after a pause of over three years. |
Let's look back at history for a moment. Inflation and interest rates always seem to come with the same lessons.
The most recent memory is 2022. From March of that year through July 2023, the Fed hiked eleven times, lifting rates to 5.25%-5.50%.
It even raised by 0.75 points four meetings in a row. Then it stopped, and only this September did it hike again.
After more than three years without pressing the hike button, it's no wonder the market is so sensitive to a single inflation reading.
In the 1970s, the US cut rates when inflation eased a bit and hiked when it came back, over and over. Inflation flared up several times, and by 1980 it reached the 14% range.
Only when Chairman Paul Volcker pushed the federal funds rate to around 20% was inflation finally beaten.
That's why the memory of backing off tightening too soon and paying more for it runs so deep inside the Fed.
1994 is the opposite lesson. That year the Fed doubled rates from 3% to 6% in a little over a year. The bond market took a heavy hit, and in December Orange County, California, declared bankruptcy.
Raise rates faster than the market expects, and something gives somewhere.
✦ 2004-2006 vs. today: what's different?
How short-term and long-term rates moved
| 2004-2006 Short-term: 17 straight hikes, 1% to 5.25% Long-term: barely moved | Today Short-term: 3.75%-4.00% after the September hike Long-term: 30-year yield near 5.6%, a 20-year-plus high |
From 2004 to 2006, the Fed raised rates 17 times in a row by 0.25 points, taking them from 1% to 5.25%. Something odd happened then.
Short-term rates went up, but long-term rates barely rose. Then-Chairman Alan Greenspan called it a conundrum.
Today it's the reverse. The 30-year Treasury yield rose to around 5.6%, a level not seen in more than 20 years, and the 10-year yield reached about 5.3%, its highest since 2007.
Whatever the Fed does, the market itself is charging more for long-term risk.
✦ What the market's legends said about the Fed and inflation
Three voices you'll meet below
| Marty Zweig "Don't fight the Fed." A saying he popularized in the 1980s. |
| Stanley Druckenmiller In essence: the Fed moves stock prices more than earnings do. |
| Warren Buffett "The single most important decision in evaluating a business is pricing power." Said at a 2010 hearing of the Financial Crisis Inquiry Commission. |
There's also an old saying among investors: "Don't fight the Fed." It's known as a phrase Marty Zweig popularized in the 1980s.
The legendary investor Stanley Druckenmiller is famous for saying, in essence, that the Fed moves stock prices more than earnings do.
When the direction of rates changes, even good companies wobble.
Warren Buffett's advice comes from a different angle. In 2010 he testified before the US Financial Crisis Inquiry Commission and said this.
"The single most important decision in evaluating a business is pricing power."
A company that can raise prices even when its costs rise survives an inflationary era. The more shaky prices and rates get, the more attention this view gets.
There's a variable specific to this year, too. Governor Barr pointed out that the AI investment boom is pushing up chip prices.
He also noted that core PCE has hit the 2% target in only two of the past 20 months. The road down for inflation is rougher than it looks.
✦ Two dates to watch
US Eastern time (ET)
| Oct 2 | September jobs report, 8:30 a.m. ET Forecast: about 90,000 jobs added, unemployment at 4.1% |
| Oct 27-28 | Fed meeting The October rate-hike decision |
Let's mark the schedule. The September jobs report comes out Friday, October 2 at 8:30 a.m. ET. The forecast is about 90,000 jobs added and unemployment at 4.1%.
This market sometimes treats good data as bad news. When August jobs beat forecasts, rate-hike expectations grew and stocks and bitcoin slid.
So a strong number could erase today's relief on inflation pretty quickly.
To sum up: today's PCE gave the Fed a bit less reason to hurry with a hike. Still, it's too early to say hikes are off the table for a while.
Core PCE inflation is still about 1.5 times the target, the Fed is divided, and long-term yields are rising on their own.
The October decision won't come into focus until we see the jobs report and the next inflation data.
This isn't investment advice. You know that, right? Take care of your hard-earned money yourself.
Well then, shall we begin today's adventure?
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