In the absence of major economic data, equities and Treasury yields were a smidge below where they started the week after reacting to a flash PMI release on Friday that suggested shrinking activity in the services sector in February (Chart 1). That said, the focus is on next week, when the second update of fourth quarter GDP and January’s Personal Income and Outlays report will give a fresh look at economic momentum and the first look at the Fed’s preferred inflation metric for 2025. Fed speakers provided some insights this week on why the data-dependent approach is key when looking to understand how inflation will evolve in a still-healthy economy.

At the start of the week Board member Christopher Waller gave a speech in Sydney with a title that left very little ambiguity, “Disinflation Progress Uneven but Still on Track. Rate Cuts on Track as Well.” The speech clearly outlined his views, including that monetary policy is restrictive and “putting downward pressure on inflation”, while economic momentum is holding up. Vice Chair Jefferson spoke later in the week, reaffirming the view that the economy and labor market are on solid footing, and the need to maintain a data dependent approach. Dr. Jefferson focused on the strength of household balance sheets and how they are supporting consumer spending. The key was that while they are generally in good position, households with lower- and middle-incomes “have less of a buffer of liquid assets than they did before the pandemic” and keeping an eye on balance sheet developments will help “inform forecasts of overall economic activity”. 

One interesting concept to monitor was Dr. Waller’s acknowledgement that progress on cooling inflation in the early part of the year has been notably slow in past years. This could be attributable to “residual seasonality”– the idea that the price adjustments that usually come in the early part of the year are now bigger than they were typically and are showing up in the seasonally adjusted data that should have accounted for them. This is an interesting wrinkle, and Dr. Waller cited research that price pressures have tended to be greater in the first half of the year relative to the second in 16 of the past 22 years. The expectation then would be that even with stronger-than-expected inflation in the early part of the year, this effect should fade into the latter part of 2025, as it did in 2024. 

With speakers emphasizing the data-dependent approach, the focus will then be on the Personal Income and Outlays report on next Friday. The spending figures could be noisy, as cold weather and large fires in Los Angeles likely disrupted economic activity, so the focus will be on what happens with inflation. Current expectations are for the core PCE price index (the Fed’s preferred inflation gauge) to clock in at around 0.2%-0.3% month-on-month in January (2.6% year-on-year, Chart 2), but as Dr. Waller suggested even an upside surprise could be due to some residual seasonality. From our lens, the Fed is likely to remain on pause until the second quarter of this year, delivering two cuts by year-end, as healthy economic activity supports the labor market and price growth.