The Fed’s vindicated by PCE data, as US stocks set to hit another record

The Fed has been vindicated. The PCE report for August, the Fed’s preferred measure of inflation, moderated more sharply than expected last month to 2.2% from 2.5%, this is the lowest level since 2021. The core PCE report rose a notch to 2.7% on an annualized basis, however, the monthly increase of 0.1% was half the rate expected by economists. Personal income and spending were both lower than expected, which suggests that the Fed made the right choice when deciding to cut interest rates by 50 basis points last week. It might also lead to investors becoming more willing to trust the Fed when it comes to future rate decisions, which may take some of the shine off the gold price in the short term.

Personal spending barely budged last month, and personal income grew at its slowest rate since July 2023. The PCE index was dragged lower by a large YoY decline in energy prices, which fell 12.7% on a 3-month annualized basis. Food prices are barely rising, they have risen by 0.7% on a 3-month annualized basis. The personal consumption index excluding food and energy is also moderating, the 3-month annualized price increase was 2.1%, down from 2.3% in July. Overall, this suggests that the fundamental drivers of inflation are gaining less traction, which is also supportive of looser monetary policy in the medium term.

Gold falls as US inflation moderates

Overall, this data will ease fears that the Fed’s rate cutting cycle will spur inflation. In the aftermath of this data, the gold price has fallen by $6 per ounce, and has backed away from Thursday’s record daily close at $2,672, which is another sign that fears about residual inflation in the US economy could be overdone. Currently there is a fairly even chance between a 25bp rate cut and a 50bp rate cut, according to the CME Fedwatch tool. The market has currently priced in 40bps of cuts for the November meeting. The dollar index has sunk on the back of the PCE data and is approaching the key 100.00 level. It is currently at its lowest level since July 2023. Back then it reached a low of 99.70, if the index breaks this level, then it could signal another leg lower for the greenback, which is good news for the pound and the yen, in our view.

The pound’s yield advantage is maintained

The chief beneficiary of the dollar’s decline on Friday, has been the pound. I’'s back above $1.34 and GBP/USD is on course to rise more than 0.5% for this week. A lower dollar tends to be good news for risk sentiment, which has already been buoyed by China’s epic stimulus plan. The S&P 500 is on track to make a fresh record high today and could close the week above 5,800. Sovereign bond yields are lower across the US and Europe and overall, it’s been a very strong quarter for bonds. Quarter to date, the 10-year US Treasury yield has fallen by 52 basis points, the German 10-year Bund yield is lower by more than 30 bps, and the 10-year UK Gilt yield is down by 15 basis points. The slower pace of decline for UK yields is giving the pound a strong yield advantage, compared to the US and the Europe. Unless we start to see a sharp deterioration in the UK economic data, or another leg lower for inflation, then the UK could maintain its yield advantage, which is pound positive as we move into Q4.

Estee Lauder and Micron lead US stocks higher

From a stock market perspective, the S&P 500 market-cap weighted index has outperformed the equal-weighted S&P 500 index during this week of record daily closes for the S&P 500.  Chinese listed shares on the Nasdaq have surged this week for obvious reasons. The weekly leaders on the S&P 500 include Intel, which has been buoyed by M&A news, Micron, which released a positive earnings report earlier this week, and Estee Lauder, the high-end cosmetics firm, which has been boosted along with European luxury firms on the back of China’s stimulus package. Estee lauder jumped above a key resistance level on Thursday and is higher by more than 15% so far this week.

China is not the only story for stock markets

This suggests that even though China is an important story for the global stock market, there are a variety of factors driving US stocks as we move into Q4. Tech is still a big theme, and we expect the Q3 earnings season to be a key driver of stocks as we enter the last 3 months of the year.

Overall, risk is well placed as we move into Q4. The question is whether less loved areas of the stock market, for example, the FTSE 100, will be able to play catch up in Q4? Another theme to watch out for is changes to regional asset allocations.  After China’s mega stimulus plan, will investors ditch under-performing developed world stocks in favour of Chinese stocks, now that Beijing its showing its resolve to boost economic growth?