Core Goods Pose Risk to Inflation Outlook Amid Disinflation Trends

Economic Insights: Gradual Disinflation and Central Bank Caution

by Faruk Imamovic
Core Goods Pose Risk to Inflation Outlook Amid Disinflation Trends
© Getty Images/Michael M. Santiago

Recent data points suggest that the economic landscape is marked by a steady, though cautious, trend towards disinflation. The April Core Personal Consumption Expenditures (PCE) index rose by 0.25% month-over-month (MoM), aligning with previous forecasts that anticipated this movement from the core Consumer Price Index (CPI) and core Producer Price Index (PPI) data. Consequently, the projected core PCE for the fourth quarter of 2024 stands at 2.9% year-over-year (YoY), up from an earlier forecast of 2.5%.

This forecast suggests a gradual decline in monthly inflation trends, largely driven by the housing sector. However, the broader trajectory of core inflation has shifted this year. Achieving the target range of 2.0% to 2.5% YoY now appears more challenging in the near term, influenced by base effects and other economic factors.

The Federal Open Market Committee (FOMC) policy baseline remains unchanged from the previous month, indicating that interest rate cuts are expected to commence in 2025. This timeline allows for a clearer trend of YoY core PCE inflation moving towards the 2% target. However, any significant weakening in the labor market could prompt earlier action from the FOMC.

Breakdown of April Core PCE Price Index

The April Core PCE data reveals nuanced trends across different sectors:

  • Core Goods: This segment saw a 0.1% MoM increase, marking the third consecutive monthly rise and the strongest three-month average since May 2023. This trend suggests a firming in core goods prices, posing an upside risk to the overall inflation outlook. With rising freight rates and an uptick in wholesale used car prices in May, this risk may become more pronounced in the coming months.
  • Housing: Housing costs rose by 0.41% MoM, consistent with CPI data. After a period of stalling, the disinflation trend in housing has resumed. However, the extent of this disinflation is uncertain. Private rent measures have stabilized recently, affecting both single-family and multi-family units. The baseline expectation is for a gradual slowing of housing inflation to about 0.3% MoM later this year.
  • Core Services Ex-Housing: This category increased by 0.27% MoM, a deceleration from March. The financial services sector, particularly portfolio management and investment advice, contributed significantly to this increase. Transportation services provided some relief, mainly due to reduced costs in air transportation.
  • Health Care: Health care inflation slowed to 0.08% MoM, maintaining a subdued trend for the third consecutive month. Despite being historically volatile, this component is expected to rise in the near term, lagging behind its PPI equivalent measure.
  • The April Core PCE data reveals nuanced trends across different sectors
    The April Core PCE data reveals nuanced trends across different sectors© Getty Images/Michael M. Santiago

Bank of Canada’s Cautious Stance Amid Economic Ambiguities

Turning our attention north, the Bank of Canada (BoC) faces a complex decision-making landscape. Despite an 80% market consensus for a policy rate cut, the BoC may choose to maintain its current rate. This cautious approach is supported by stronger-than-expected domestic demand, particularly in housing, which has driven GDP growth in the first and second quarters of this year.

Canada’s employment figures and hours worked have shown robust growth, adding layers of complexity to the BoC’s assessment of the output gap and inflation trends. The BoC may delay any rate cuts until July to gather more confirming evidence of a widening output gap and convergence of inflation towards the target range of 1-3%.

If the BoC does proceed with a rate cut, it is expected to adopt a measured and data-dependent approach, avoiding any declaration of victory over inflation. Lower oil prices since mid-May, which have yet to fully impact Canada’s CPI, could also be a forward-looking factor in BoC’s disinflationary trend considerations.

Implications for Currency Markets and Global Economic Policies

The broader implications of these economic trends and central bank policies extend to currency markets and global trade dynamics. The USD/CAD exchange rate, for instance, is expected to be influenced by BoC’s policy decisions. A cautious BoC, combined with a robust domestic economic backdrop, may limit the upside potential for USD/CAD in the near term.

In the broader foreign exchange (FX) landscape, the recent volatility in USD/JPY highlights the vulnerability of high-yielding long Emerging Market (EM) FX/JPY carry trades to contagion. The unwinding of these trades, influenced by geopolitical and economic events such as elections in South Africa, Mexico, and India, has prompted traders to consider alternative funding currencies like the Chinese Yuan (CNY).

Navigating Economic Uncertainties

As central banks worldwide navigate the complexities of inflation control, economic growth, and market stability, their cautious approaches underscore the uncertainties inherent in the global economic landscape. For Canada, proving fiscal responsibility and maintaining central bank autonomy will be critical to stabilizing the USD/MXN pair and achieving sustainable economic growth.

While gradual disinflation remains the base case for the U.S., core goods present an upside risk to this outlook. The BoC’s cautious stance reflects the broader challenges central banks face in balancing inflation control with economic growth. As we move forward, these dynamics will continue to shape economic policies and market trends, underscoring the need for vigilant and adaptive economic strategies.