Morgan Stanley anticipates a monthly increase of 0.35% in February’s core personal consumption expenditures (PCE) price index. This rise is attributed to ongoing goods inflation and a recovery in core services prices, excluding housing.
In contrast, the headline PCE index is expected to grow by a lower rate of 0.32% month-on-month, influenced by decreasing food and energy prices. The variation between headline and core inflation illustrates the persistent price pressures monitored by the Federal Reserve.
Core Inflation Remains Elevated
The forecast might indicate that progress in disinflation is stalling, which could affect the Fed’s rate cut decisions. Market participants are closely observing the forthcoming PCE data, set to be released at 1230 GMT.
Taken together, this outlook implies that inflationary forces beneath the surface remain active, particularly when looking past the more volatile categories like food and energy. While the broader gauge appears to be softening a touch—thanks mainly to temporary reprieve in commodity costs—the underlying demand for goods and a gathering strength in services suggest inflation is not easing as quickly as policy-makers would prefer.
Morgan’s projection of a 0.35% increase in core PCE for February, even though not alarmingly high, reinforces the idea that downward progress on consumer prices has hit resistance. Goods prices, often considered stabilisers in times of declining inflation, are now contributing again to upward pressure. At the same time, services—especially when stripping out housing—are recovering, adding another layer of upward momentum to core inflation.
The headline number, coming in slightly softer at 0.32%, should not be misread as a clear sign of improvement. Rather, it points to short-term relief, likely brought by declining energy costs and possibly food price moderation—both of which can reverse quickly depending on supply conditions and geopolitical events.
Market Sensitivity To Inflation Divergence
When we observe this divergence in inflation indicators, it complicates the task for policy-makers. While on paper it might appear that inflation is easing gently, the more telling metric—the core index—continues to climb at a pace above the comfort zone of many central bankers. If we examine prior market behaviour, traders have typically responded with heightened sensitivity to this kind of divergence, especially when core strength is unexpected after months of tightening policy.
Yellen’s recent statements have not hinted at urgency to pivot policy soon, and Friday’s data could confirm their caution. If we compare current levels of services inflation with trends from late last year, acceleration in these components could indicate stickier inflation than previously projected. This alone could delay action on rates, especially while employment remains solid.
So what does this mean for our trading desks? The answer is in positioning. With the PCE report due for release at 1230 GMT, near-term volatility is expected, particularly in interest rate futures and broader risk assets. That includes Treasuries and instruments sensitive to short-term rate expectations, where repricing has shown to occur rapidly following stronger-than-expected inflation prints.
Gorman’s view earlier in the month supported a cautious bias, and that seems prudent here. Bond yields may regain their footing if the core print surpasses consensus by even a marginal amount. Conversely, an unexpected dip may lead to renewed speculation of easing in the summer months, but that is not the base case now, based on the forecast.
In scenarios like this, where headline and core data diverge, the curve tends to reflect that tug-of-war. We’ve seen this before—short-end remaining sticky, while the long-end anticipates policy adjustments further out. It’s vital to focus on duration exposure and convexity, particularly when intraday moves threaten to break recent technical levels.
Volatility should pick up in the immediate lead-up to the release and is likely to spike in the aftermath. If core services surprise to the upside, the recalibration of short-term rate expectations could be swift. Adjust exposure accordingly—not just directionally, but also in terms of gamma risk and liquidity cushions in thin books.
We’ve maintained a flexible approach in weeks like this, adjusting bias quickly when key data prints defy expectations, and that blueprint remains appropriate now. Use the next 24 hours to evaluate optionality strategies, especially ones that let us lean into potential moves without committing aggressively ahead of the number. And keep watch on correlated assets—oil, retail equities, and the dollar may all respond in line with revised inflation expectations.
With the inflation outlook looking less linear than hoped, risk recalibration will continue to be the theme across desks.
