Wall Street Analysts: Inflation will ease. What impact will it have on the outlook for cryptocurrencies?

Author: Scott Garliss, CoinDesk; Compiler: Tao Zhu, Golden Finance

The inflation rate continues to decline.

In the above chart, at the end of 2019, the price of white bread was $1.36. At the beginning of 2020, prices remained stable. Then, by the end of the year, they rose 13% to $1.54. In 2021, prices remained stable, and then soared 21% in 2022. In 2022, the growth rate slowed down, increasing by another 8%. But this year, bread prices have stabilized and declined.

This dynamic reminds me of what’s happening with inflation across the country. As the cost of goods has risen, demand has cooled. Individuals may not be going out to lunch as often as they once did. This dynamic change tells me that price pressures should ease further when August personal consumption expenditures are released in late September. This would support further rate cuts from the Federal Reserve this year and underpin a steady rise in risk assets such as cryptocurrencies.

But don’t just take my word for it, let’s look at what the data tells us…

If we want to understand what’s happening with PCE growth, we need to look at the big picture. Therefore, we have to look at this number on an annualized basis. That way, we don’t let any one-off monthly surges distort the more important long-term picture.

The breakdown of the overall PCE index components shows that goods make up about 35% and services make up about 65%. Therefore, services will have a greater impact on the direction of the index. However, core PCE (minus food and energy) is what we really want to focus on.

So, let’s take it a step further. Food and energy are non-durable goods (goods with a useful life of less than three years). This subset makes up about two-thirds of the goods component of the PCE, with durable goods (those with a useful life of more than three years) making up the other third.

Central banks like to exclude food and energy because those prices are more volatile. That way, policymakers feel like they are smoothing the numbers. So when we remove them from the inflation equation, we get the core PCE index, which is mostly made up of service prices.

Now, let's take a closer look at the services component. It explains the difference between the BEA and BLS inflation measures. It's why PCE growth tends to be lower than the CPI.

In the PCE, housing including utilities makes up about 17%, health care makes up about 17%, financial services and insurance makes up about 8%, other services makes up about 8%, food (remember the services aspect) and accommodation makes up about 8%, recreation services makes up 4%, and transportation makes up about 3%. This is very different from the CPI, where housing makes up more than 36% and health services make up only 6%.

According to the Bureau of Labor Statistics, in August, housing prices rose 0.5%, health care services shrank 0.1%, financial services fell 0.3%, insurance costs fell 0.2%, hotel room costs rose 1.8%, recreation services remained unchanged, and transportation and warehousing services slipped 0.1%.

If we adjust these numbers in a weighted manner, we see that the growth in August was closer to 0.2%. This is in line with the Cleveland Federal Reserve Bank and the consensus forecast of 0.2% growth.

Now, let's see what a 0.2% year-over-year increase would look like...

According to my forecast, a 0.2% monthly increase would translate into a 2.7% annualized growth rate for core PCE. That would be in line with Wall Street's 2.7% growth expectations, but below the Cleveland Fed's forecast of 2.8%.

More importantly, the average growth rate over the past six months would have been 0.2%. That would translate into a 2.4% annualized core growth rate. That would be below the current growth rate, implying that growth will continue to slow going forward.

If PCE performs as I expect, it will boost the prospects for Fed easing monetary policy. Because, based on the new inflation rate and the effective federal funds rate, real interest rates will have a 2.7% downside cushion before they stop weighing on inflation growth.

In other words, this change will give our central bank enough room to start cutting rates without triggering a rebound in inflation. This should support the outlook for slower but not collapsing economic growth, and support a steady rise in risk assets like Bitcoin and Ethereum.