Citi Predicts Dovish Surprise from the Fed, Core PCE Near 2% May Affect Rate Hike Path

Citi believes that if the core PCE growth rate remains close to an annualized level of 2% in the short term, the tightening path after the September rate hike may change. The key question is whether the Fed's originally expected subsequent rate hikes will still occur, rather than an immediate shift to rate cuts. Citi economist Andrew Hollenhorst stated that the U.S. economy is not overheating, and the minutes from the September meeting show that at least some officials did not view the economy as clearly overheating, but agreed to raise rates based on risk management considerations given the upward risks to inflation. This means that if underlying inflation continues to cool, the preventive rationale for the September rate hike may quickly weaken. Currently, most officials still expect one more rate hike before the end of the year, but the minutes did not indicate urgency for consecutive hikes in October. Citi is focused on the month-on-month core PCE, which rose 0.2% in August, revised from 0.1% in July, and increased 3.0% year-on-year in August. If it remains around 2% annualized for several consecutive months, it should be seen as inflation retreating at a "sufficient pace" as required by the Fed. Citi is cautious about the transmission of energy shocks to core inflation, believing that businesses have not yet broadly passed on energy costs to core prices. The baseline scenario expects core inflation to remain low over the next four months and points out that there are downside risks to core inflation in September. The so-called "dovish surprise" is more likely to indicate that the rate hike cycle will end earlier than the dot plot and market expectations, rather than a rapid shift to rate cuts. Fed Chair Waller has not yet clarified the standard for "sufficient pace," but a core PCE annualized rate of about 2% for several consecutive months can be seen as a reasonable reference.

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