CPI cooling is good for interest rate cuts? Morgan Stanley pours cold water: PCE remains strong, and the Federal Reserve will still only cut rates once this year!

The overnight inflation data released in the United States showed that the CPI was significantly below expectations, indicating clear signs of easing inflation, which sparked market speculation about the Federal Reserve potentially accelerating interest rate cuts.

However, the latest research report from Morgan Stanley poured cold water on this, pointing out that although the CPI data has improved, the core PCE inflation data, which is more favored by the Federal Reserve, will remain strong, and there may only be one rate cut this year, possibly in June. JP Morgan's report also corroborated this view, believing that the PCE data remains robust.

Core PCE Hard to Cool, Fed Rate Cut Expectations May Fall Short

On March 12, Morgan Stanley analysts Michael T Gapen and Diego Anzoategui released a report stating:

“The growth in core goods prices within the CPI exceeded our expectations, particularly in categories such as clothing and computer software that have a significant impact on PCE.”

Specifically, the report showed that the overall CPI increase was below expectations, and the month-on-month increase in core CPI also showed a slowdown:

• The U.S. CPI in February rose 2.8% year-on-year, the lowest since November last year; the expected value was 2.9%, and the previous value was 3%; it rose 0.2% month-on-month, the lowest since October last year.

• The U.S. core CPI in February rose 3.1% year-on-year, the lowest since April 2021; the expected value was 3.2%, and the previous value was 3.3%; it rose 0.2% month-on-month, the lowest since December last year.

Morgan Stanley pointed out:

“The main reason for this slowdown is the weakness in service prices, particularly the decline in airfares and owners' equivalent rent. The unexpected drop in owners' equivalent rent also led to housing inflation being lower than expected.”

Nevertheless, commodity inflation still maintained positive growth, with core goods prices rising by 0.22%, mainly influenced by the following factors: first, the impact of wildfires on car prices is fading; second, clothing prices have rebounded; third, prices of other goods such as tobacco have accelerated.

Based on the CPI data, analysts predict that the core PCE will grow by 0.32% month-on-month in February, with a year-on-year growth rate of 2.7% over 12 months. The PCE growth rates for 6 months and 3 months are expected to accelerate to 2.96% and 3.29%, respectively.

Based on this data, Morgan Stanley maintains its view:

“The Federal Reserve will maintain a prolonged pause in its policy and will only cut rates once in 2025, possibly in June.”

JP Morgan: PCE Data Remains Strong

At the same time, JP Morgan also released a report on the February CPI, stating that the U.S. February CPI data was below expectations, but core goods inflation remained strong, with the increase in core goods (excluding automobiles) reaching the strongest level since April last year.

Therefore, JP Morgan holds a view similar to Morgan Stanley, believing that the PCE data will remain robust:

"Based on the CPI report, we estimate that the core PCE will rise by 0.31% in February, which will increase the three-month annualized rate from last month's 2.4% to 3.3%."

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