Core PCE inflation falls, labour market remains tight in the US

The release of PCE inflation data for October will have reassured the Fed.¹ Following an increase in headline PCE inflation in September to 6.3% year-on-year (y/y) (0.3% month-on-month (m/m)), headline PCE inflation fell to 6.0% y/y in October (0.3% m/m) (see Chart 1). Year-on-year, goods prices rose 7.2% and services prices increased 5.4%.

These moves largely reflected increases for food and energy prices, which were up 11.6% and 18.4% y/y respectively. Excluding the volatile food and energy components, core PCE inflation slowed from 5.2% y/y (0.5% m/m) in September to 5.0% y/y (0.2% m/m) in October. Core PCE inflation is the Fed’s preferred measure to judge underlying inflation pressures and the decline in October will therefore have reassured the Fed that inflation is likely to have peaked.

Chart 1. PCE inflation (% change, year-on-year)

Source: Refinitiv and EFGAM calculations. Data as of 02 December 2022.

At the same time, November’s non-farm payroll data confirmed the tightness of the US labour market.² Total non-farm payroll employment increased by 263,000 in November, below the increase of 284,000 in October but significantly above expectations of 200,000. The unemployment rate was unchanged at 3.7%.

Job openings data, which is available until October, shows that the ratio of vacancies to unemployed persons declined from 1.86 in September to 1.71 in October. This points to a marginal easing in the tightness of labour market conditions in October. Nonetheless, the ratio remains significantly above historic norms and highlights continued pressures in the labour market (see Chart 2).

Chart 2. Vacancies/Unemployed

Source: Refinitiv and EFGAM calculations. Data as of 02 December 2022.

This is closely associated with wage growth, which is keenly watched by the Fed and which remained uncomfortably strong in November. Average hourly earnings for all employees on private non-farm payrolls rose 5.1% y/y (0.6% m/m), above the upwardly-revised 4.9% y/y (0.5% m/m) registered in October. In a speech on 30 November, Fed Chair Jerome Powell noted that only tentative signs of labour demand moderation have been seen.³ This is important because the Fed will want to see a reduction in wage pressures before it is able to declare victory in its fight against inflation.

The Fed will therefore likely need to continue to raise interest rates several more times. In our view, these rate increases will come at a slower pace; we expect the FOMC will increase the federal funds target rate by 50 basis points in its meeting on 14 December. This interpretation is supported by a statement in Chairman Powell’s speech, noting that “the time for moderating the pace of rate increases may come as soon as the December meeting”.

The release of the October PCE data will have provided further support to this view. While the labour market remains tight, November’s non-farm payroll data is unlikely to sway the FOMC towards a steeper rate hike given the significant speed at which it has raised rates already and the lagged impact of monetary policy.

¹ http://go.pardot.com/e/931253/ncome-and-outlays-october-2022/2mr54/137262897?h=c-NWY2yVQi9NPbLuEc0hZgTNLV-M-D-Dz_g7UREKqe8
² http://go.pardot.com/e/931253/news-release-empsit-nr0-htm/2mr57/137262897?h=c-NWY2yVQi9NPbLuEc0hZgTNLV-M-D-Dz_g7UREKqe8
³ http://go.pardot.com/e/931253/nts-speech-powell20221130a-htm/2mr5b/137262897?h=c-NWY2yVQi9NPbLuEc0hZgTNLV-M-D-Dz_g7UREKqe8