How Economic Data Affects The Feds Outlook

These days, all eyes have been on the Federal Open Market Committee (FOMC). Markets have been walking on eggshells when it’s time to announce their next move. It is easy to understand the importance of the decision itself, but for an investor, it may be more important to understand what is influencing their decisions.

Federal Reserve (Fed) Chairman Jerome Powell has consistently stated that the Fed will not pivot from hawkish to dovish. Tonality for the Fed has remained the same, but when a rumor about a dovish pivot spread through the market a couple of weeks ago, the market reacted positively to it.

Rumors that the Fed would be taking a different stance on interest rate hikes at their meeting on November 2nd spread widely. This would be a different stance from their previous comments, indicating that the Fed sees improvement in the economy, which would be bullish for the market.

Rumors were confirmed through the FOMC statements, but the harsh reality has since riddled the market after listening closer to Powell’s comments. Powell stated that the Fed intends to lower rate hikes, but when the time is right. He then doubled down on his remarks saying that the market likely got ahead of itself, and at this moment, they do not see a reason to pull back the reigns. While Powell reiterated the Fed’s commitment to finishing the job, he mentioned macro econ data would influence their decisions moving forward.

Macro reports influencing Fed

Powell has mentioned the Personal Consumption Expenditures (PCE) price index as a macro indicator that the FED uses. When looking at the PCE data, there is a trickle-down effect to get there. Starting with the Producer Price Index (PPI), data will trickle to the Consumer Price Index (CPI) and, ultimately, PCE. Let’s look at the relationship between these reports and how understanding them can help you piece together the puzzle that the Fed is putting together.

Top of the funnel

This puzzle starts with the PPI report. The reason for the PPI report at the top of the funnel is that a producer will see inflation before the consumer. This is because an item has to be produced before a consumer can buy it. For example, Kellogg’s may report cereal production inflation before the box ever hits the shelves. Months later, the consumer will feel the trickled-down inflation when the cereal box has a price tag slightly higher. This is just one example of using PPI to forward project CPI. All this means is that Producer inflation needs to be seen before anything else.

The next step in improvements

After PPI has shown signs of a reduction in inflation numbers, the following data report that needs improvement will be CPI. Consumer inflation will be the middle of this equation to the Fed slowing rates. Although the CPI report is the most well-known, it can be misleading on a report-to-report basis. The Fed is likely looking for a consistent string of improvements rather than just a one-off. One reason an individual report is not the end-all-be-all is that it can often take 2-3 months for the PPI numbers to translate to a consumer adequately. The Fed is likely looking for a streak of at least two consecutive reports before changing its hawkish tone.

Finalizing a growing economy

Lastly, the Fed is looking directly at the PCE numbers. Speculation on why this is the report Powell keeps using by name is that it is the last piece of this puzzle. The PCE numbers can reflect a growing economy when the inflation seen by consumers on the shelves improves consistently. This is because PCE is the report that tracks personal spending. When PCE numbers can display that spending is increasing, this should be the first sign of a growing economy, and then the Fed can lay off the gas a little bit.

Data must pivot, then Fed can follow

Ultimately, these reports will have to change before the fed does. Powell has stuck to his guns and proven that they are unwilling to pivot unless these macro econ reports indicate the time to do so is correct. Watching these reports paint a picture should bring clarity to the following rate hike announcement in December. 

Yes, the intentions are to reduce rates, but at this point, it looks like an uphill battle that the Fed will continue to fight.