Markets are 65% certain of a rate-cut by year-end. Are they right?

This morning, the Bureau of Economic Analysis in the U.S. Commerce Department released its Personal Consumption Expenditures Price Index. This index, otherwise known as the PCE Deflator, is the Fed’s preferred gauge to measure inflation. According to Moodys, the PCE Deflator is defined as follows:

“The core PCE price index measures the prices paid by consumers for goods and services without the volatility caused by movements in food and energy prices to reveal underlying inflation trends. Food prices consist of those included in the PCE category of “food and beverages purchased for off-premises consumption.” Prices included in the PCE category “food services and accommodations” are not included in the “food” price index because these services prices tend to be far less volatile than those for food commodities such as meats, fresh vegetables and fruits. Energy prices consist of those included in the PCE categories of “gasoline and other energy goods” and of “electricity and gas” utilities.

PCE Index from 1959 to Present

The PCE index was flat in March versus February and increased YOY by 1.6%, the lowest increase in 14 months and below the Fed’s target of 2%. If the metric stays below 2%, many believe the Fed is unlikely to raise rates and may cut rates. A rate cut is something markets are betting on, with the CME Fedwatch Tool assigning nearly a 65% probability of cut rates by year-end. The Trump administration is unsurprisingly arguing for a rate cut, as one lever to ensure continued economic growth into the 2020 election. Let’s unpack the PCE index numbers to see what is going on.

Versus Last Month

Today’s headline is that the PCE deflator was flat versus last month. Technically, it was up 0.046%, which when rounding to 1 digit, does equate to 0.0%. Of note, there are 47 other month-over-month periods since 1959 that had smaller increases, including 14 months where the PCE deflator fell. So while there was no more than a tiny change, this alone is not sufficiently prescriptive for Fed rate cut action.

Year over Year

The 1.6% YOY increase for March is the lowest YOY increase for any month since January 2018. At face value, this would bolster the case for rate cuts. However, when you look at the 12-month simple moving average of the YOY increases, they are starting to trend up, driven by March, May, June, July, and September of 2018 all registering the magic 2% YOY increases. Looking at this, it’s hard to argue that the bottom has fallen out of the PCE deflator.

Versus End of Last Quarter

The end of quarter comparison paints a slightly different picture. At +0.18% versus the end of Q4 2018, this is the lowest end of the quarter versus the end of last quarter growth rate since 2010. It implies a slowdown of growth in the PCE index.


Officially, the Fed is currently on hold and watching the data. Consumer spending grew by a robust 0.9% in March, so the possibility of future PCE index growth remains. This growth may tilt the scales one way or the other. Given the conflicting data, the Fed’s on-hold position strikes me as prudent.


Any opinions or forecasts contained herein reflect the personal and subjective judgments and assumptions of the author only. There can be no assurance that developments will transpire as forecasted and actual results will be different. The accuracy of data is not guaranteed but represents the author’s best judgment and can be derived from a variety of sources. The information is subject to change at any time without notice.