Easing US core PCE may lead to some additional pricing of Fed rate cuts this year

Month-on-month core PCE in February in line with Chair Powell’s expectations for a reading “well below 30bp”

• USD: In data released Friday, US core PCE inflation rises 0.26%MoM in February, matching consensus expectations for 0.3% gain but January core PCE inflation is revised up to 0.45% from 0.42%, a print that now rounds to 0.5%MoM. But on a YoY basis, core PCE inflation eases from an upwardly revised 2.9%YoY in January to 2.8%YoY in February even though 6-month core PCE rises from 2.56% to 2.89% and core services excluding housing is up a modest 0.18%MoM following a strong 0.66% increase in January.
   
• USD: Other components of Friday’s data include personal income that is up a modest 0.3%MoM in February while nominal spending rises a strong 0.8%, that is above-consensus for a 0.6% gain. This leads the savings rate to fall from 4.1% to 3.6%. In real terms, spending rises 0.4%MoM with a modest 0.1% increase in real goods spending but a strong 0.6% increase in real services spending. Meanwhile, real spending is revised lower to a 0.2% decline in January.
   
• USD: Core PCE inflation rising 0.26%MoM in February and revised only slightly higher to 0.45% in January is in line with Chair Powell’s expectations for a reading “well below 30bp”. Details of the report are also modestly softer than consensus expectations (which were around 0.30% for February core PCE and revisions to around 0.48% in January) and could lead to some additional pricing of rate cuts this year. Fed officials will likely be particularly comforted by a modest 0.18% increase in core services prices excluding housing as a sign that January strength will not repeat.

March Tokyo CPI—base effects see inflation moderating

• JPY: In data released on Friday by the Statistics Bureau of Japan, Tokyo’s core CPI (excluding only fresh food) rises 2.4% YoY in March, down slightly from a 2.5% YoY gain in February but in line with consensus. Meanwhile, core-core inflation (CPI excluding fresh food and energy) also comes in lower than the prior month at 2.9% YoY in March, slowing from a 3.1% YoY rise in February. However, both sets of data are well above the BoJ’s longer term 2% inflation target and it is base effects that are largely responsible for the lower outcomes particularly impacting goods inflation while inflation for services remains largely sticky.
   
• JPY: Citi Research expect Japan’s nationwide core CPI to stay in the higher-2% YoY range from May —　based on the Tokyo CPI data, Citi Research estimate March nationwide core CPI (due out April 19) will likely rise 2.6% YoY, down from a 2.8% YoY advance in February followed by a 2.3% YoY increase in April. Given a planned hike for renewable energy surcharges in May and the end of electricity & gas price subsidies in June, core inflation looks likely to hover in the higher 2% YoY range in May and beyond. What is crucial for a future BoJ exit however, will be whether businesses are able to pass higher labor costs on to service prices. April and May are typically months when prices are revised in Japan and if this evident this year then the possibility of a BoJ July rate hike would likely increase.

Citi Research upgrade Japan’s inflation outlook

• JPY: In response to recent government energy-related measures, Citi Research revise up their 2023 core CPI forecast for Japan from 2.2% to 2.7% with monthly core inflation likely to rise to 2.9% YoY this summer. Additionally, it has been reported that subsidies for electricity and gas bills will be cut in half for May usage and completely ended for June usage (March 28 Sankei Shimbun). These effects are likely to be seen in the CPI from May to July.
   
• JPY: Spring wage hikes have been higher than expected and Japanese companies have aggressively raised prices last year with corporate profits reaching a high level and the labor share of income declining. Therefore, the passing on of labor costs to prices is likely to progress gradually, leading to sticky inflation centered on services. But if the CPI in April or May show surprisingly stronger pass-though, the BoJ could hike rates as early as in July.

• JPY: Citi Research forecast core inflation will rise to 2.9% YoY this summer but note that the BoJ’s inflation forecast already takes into account the end of subsidies for electricity and gas bills and is expected to incorporate only the effect of the renewable energy levy. This means Citi Research’s outlook for core-core CPI, excluding energy will not change significantly. Assuming the final result is a base wage hike of 3.5% in April/ May 9when the final results of wage negotiations are in), which will be directly reflected in scheduled earnings in Q3, Citi Research expect the YoY change in real wages will turn positive though the impact on core-core CPI will be somewhat less than if the energy price measures had not been factored in.

• JPY: That said, the recent measures regarding energy prices may make for a lesser tolerance for a weaker yen notwithstanding the historically high wage hikes seen earlier in March. In particular, a rise in the ¥/$ rate to ¥160/$ could have a significant impact on the BoJ's inflation outlook, potentially leading to policy changes. Citi Research FX strategists believe Japan’s MoF may intervene in the ¥152/$-¥155/$ zone as the recent escalation of communication by MoF officials against yen depreciation suggests the current FY rate (¥151/$) is close to the trigger point for intervention. With the Cabinet's approval ratings slumping, the Kishida administration is likely wary of whether the public will become dissatisfied with a weak yen.

• JPY: If FX intervention fails to stop the depreciation, then at what JPY level will the BoJ decide to raise interest rates? Governor Ueda has stated that if the weaker yen has a major impact on the outlook for the economy and prices, the BoJ will consider monetary policy responses. If JPY remains at ¥150/$, Citi Research expect the BoJ outlook report in April will show core-core CPI inflation to be 2.1% in FY2024 and 2.0% in FY2025 and beyond. On the other hand, if the dollar yen rises to ¥160/$, the BoJ will likely raise its forecasts to 2.4% in FY2024 and 2.2% in FY2025. This would seem to be the major impact that Governor Ueda was speaking of.

Week Ahead:

US - March nonfarm payrolls, ISM manufacturing & services and February JOLTS job hirings in focus this week

• USD: US March Nonfarm Payrolls – Citi: 150k, median: 203k, prior: 275k; Private Payrolls – Citi: 110k, median: 170k, prior: 223k; Manufacturing Payrolls – Citi: -15k, median: 10k, prior: -4k; Average Hourly Earnings MoM – Citi: 0.4%, median: 0.3%, prior: 0.1%; Average Hourly Earnings YoY - Citi: 4.2%, median: 4.1%, prior: 4.3%; Unemployment Rate – Citi: 3.9%, median: 3.9%, prior: 3.9%
   
• USD: despite stronger over-200k job growth in each of the last three months, Citi Research expect a slowing in payrolls with a 150k increase in March due to the start of some less favorable seasonal factors through the spring. Even the strong February employment gains were accompanied by substantial revisions lower to employment in January and December. Citi Research expect a modest decline in goods sector employment in March, with manufacturing employment falling 15k. Meanwhile, average hourly earnings are expected to rise a solid 0.4%MoM in March while year-on-year average hourly earnings should moderate only slightly to 4.2%. After rising to 3.86% in February, the unemployment rate will be a very important aspect of March labor market data. Citi Research expect the unemployment rate to remain unchanged at 3.9% in March but with slight downside risks.
   
• USD: JOLTS February Job Openings – Citi: 8855k, median: 8770k, prior: 8863k – Citi Research expect JOLTS job openings to fall only modestly in February to 8855k from 8863k in January, a decline consistent with a continued move lower in high frequency data on job postings from Indeed.com. Demand for workers appears to be moderating based on a variety of data like the NFIB survey of hiring plans and payrolls of temporary help workers. Evidence of weaker demand for labor includes the hiring rate in the JOLTS survey, which has fallen throughout the last year and hovers around 2014-15 levels. Weaker hiring could result in much weaker job growth during the spring months (March-June) when hiring typically picks up substantially. However, layoff rates in the JOLTS survey remain low, consistent with still-low levels of initial jobless claims.

• USD: US March ISM Manufacturing – Citi: 48.0, median: 48.4, prior: 47.8 - Citi Research expect ISM Manufacturing to improve only modestly in March to 48 from 47.8 which would point to manufacturing activity contracting at a slightly slower pace. The production and employment sub-indices might bounce back modestly after declining in February. Manufacturing employment has been weak in recent months and further declines are likely in March payrolls. However, Citi Research see upside risks to the manufacturing prices index with gasoline prices continuing to pick up.

• USD: US March ISM Services – Citi: 52.8, median: 52.8, prior: 52.6 - unlike manufacturing diffusion indices that have been more mixed recently, services indices have consistently remained in expansionary territory. This is consistent with consumption data that shows real services consumption continuing to grow at a solid pace. Citi Research expect ISM Services to increase very modestly in March to 52.8 from 52.6 which would point to just a slight acceleration in services activity growth. Most attention will be on the employment details such as the percent of industries that are reporting higher employment which have been weaker in recent months. The employment sub-index could remain in modest contractionary territory as well. For now, services activity remains an important driver of growth but we with downside risks in 2024.

Euro area and UK – Euro area March (flash) inflation data, Swiss CPI, Riksbank policy minutes and UK Decision Maker Panel in focus this week

• EUR: Eurozone March inflation data (flash) — Euro area inflation — Citi Research see another relatively solid euro area HICP print for March, with headline inflation stable at 2.6% (consensus 2.5%) and core stable at 3.1% (3.0%). This would imply core HICP up by 0.4% MM (SA), driven by an early-Easter effect which should unwind in April. Most countries are out already, only German inflation will be released this week ahead of the euro area (Citi Research expect headline HICP inflation to have eased from 2.7% to 2.3%). Euro Area HICP Inflation, March – Citi Forecast 2.6%YY, Consensus 2.5%YY, Prior 2.6% YY; HICP Core, March – Citi Forecast 3.1%YY, Consensus 3.0%YY, Prior 3.1% YY; ECB CES 1Y Inflation Expectations, February – Citi Forecast 3.4%, Prior 3.3% (rising fuel prices, utility bills); ECB CES 5Y Inflation Expectations, February – Citi Forecast 2.5%, Prior 2.5%.
   
• CHF: Switzerland: CPI Inflation, March – Citi Forecast 1.2% YY, Consensus 1.4% YY, Prior 1.2% YY; CPI Core 1, March – Citi Forecast 1.1% YY, Prior 1.1% YY
   
• SEK: Riksbank Minutes of 26 March meeting
   
• GBP: UK Decision Maker Panel in focus — in focus for the UK this week will be the Decision Maker Panel survey. The inflation expectations data has taken on additional salience for the MPC as more of the committee look to evaluate the potential leading characteristics of headline inflation – particularly its pass through into domestic factors such as wages and services prices. Here inflation expectations data are a central driver. Citi Research expect the DMP to continue to signal good news on that front, with year ahead price growth expectations falling to 4.1%, and a 1.1pp deceleration in price growth over the coming twelve months – backing up data last week from the Citi YouGov survey.

Japan – BoJ’s March Tankan report in focus this week

• JPY: The BoJ’s March Tankan report is likely to show lower confidence at manufacturers and improving sentiment at non-manufacturers — Citi Research expect large manufacturer business confidence DI to decrease from +13 in December to +10 in the March Tankan (after the sample universe change). An inflow of cheaper manufactured goods from China as well as auto supply disruptions likely dampened manufacturer sentiment modestly. Meanwhile, the headline DI at large non-manufacturers will probably rise from +32 in December to +34 in March. Non-manufacturers likely benefitted from an inbound demand recovery and progress in price pass-throughs.

Commodity Bloc – RBA March minutes and Canada jobs data in focus this week

• AUD: Markets will play close attention to the RBA Minutes of the March Policy board Meeting, which were conducted prior to the steep fall in the unemployment rate in February. The Board shifted towards a more neutral bias, so the minutes will reveal whether rate hikes were on the agenda (which was the case in February), or whether the Board only thought about keeping rates on hold in March.
   
• CAD: Canada March Net Change in Employment (Mar) – Citi: 35k, median: xx, prior: 40.7k; Unemployment Rate – Citi: 5.9%, median: xx, prior: 5.8%; Average Hourly Wages Permanent Employees – Citi: 5.0%, median: xx, prior: 4.9% - Citi Research expect 35k jobs added in March, only modestly softer than the 40.7k increase in January but with slight downside risks. Some strength could come in a rebound in goods sector employment, which has declined in the last three months. Services employment however could soften in March. A March employment report in line with expectations would continue a trend of still-rising employment, but at a pace that is not quite strong enough to keep the unemployment rate from rising given a backdrop of very strong population growth. Citi Research expect the unemployment rate to rise to 5.9%. Wage growth will be a consistently important element of monthly employment reports, and Citi Research expect average wages of permanent employees to be essentially unchanged in March at 5.0% compared to 4.9% in February. BoC officials note some signs of easing wage growth in data other than the Labor Force Survey, which could suggest downside risks to March LFS wages. Overall, the March employment data is unlikely to reveal much new information about the health of the labor market. Without a clear near-term weakening in the labor market and activity data, and an indication in the summary of deliberations from the March meeting that downside risks to growth have fallen, BoC officials are unlikely to have enough evidence to cut policy rates as soon as June.