Goldman Sachs: US PCE inflation rose in the first quarter, but will subsequently decline

The U.S. PCE index for March will be released this Friday evening, with the core PCE, the most favored inflation indicator by the Federal Reserve, expected to further influence market expectations for the interest rate path for the year.

Data compiled by the media shows that the year-on-year growth rate of the comprehensive PCE index for March is expected to rise from the previous value of 2.5% to 2.6%, while the core PCE index is expected to decrease from the previous value of 2.8% to 2.7%. Both the month-on-month growth rates for comprehensive and core PCE are expected to remain unchanged at 0.3%.

This indicates that PCE inflation in the first quarter in the United States is expected to remain at a high level.

Goldman Sachs analyst team led by Jan Hatzius predicts in their latest research report that in the first quarter of 2024, the annualized growth rate of core PCE in the United States will increase from an average of 1.9% per month in the second half of 2023 to 4.0%, mainly driven by sectors such as consumer electronics, financial services, and healthcare.

However, with the aforementioned momentum fading, Goldman Sachs expects that from the first quarter to the end of the year, the monthly consecutive growth rate of core PCE inflation will slow down from an average of 0.33% to 0.18%.

Four Major Drivers of First Quarter PCE Increase

According to the Goldman Sachs research report, the main driving factors behind the increase in PCE in the first quarter are mainly four:

Consumer Electronics: In the fourth quarter of last year, merchants carried out year-end promotions more aggressively than usual, leading to the second largest quarterly decline in consumer electronics prices in history. Therefore, consumer electronics prices rose significantly in the first quarter of this year.

Goldman Sachs expects consumer electronics and software prices to grow in the first quarter at an average annualized rate of 21.9% per month (compared to the second half of 2023, the non-annualized inflation rate increased by 6.8 basis points per month), marking the largest quarterly growth since 1959.

Financial Services: The growth in financial services prices is closely related to the rise in U.S. stocks. The S&P 500 index rose by an average of 3.1% per month in the first quarter of 202, compared to an average of 1.3% per month in the second half of 2023.

Goldman Sachs expects financial services prices to accelerate to an average annualized growth rate of 10.1% per month in the first quarter of 2024 (compared to the second half of 2023, the non-annualized inflation rate increased by 4.5 basis points per month).

Healthcare Services: The early catch-up of costs related to the epidemic led to price increases.

Goldman Sachs wrote:

In the first quarter of 2024, healthcare services inflation remains at a high level (compared to the second half of 2023, the average monthly growth rate increased by 2.4 basis points).

Throughout 2023, healthcare price growth lagged behind the overall cost environment, and the rapid growth in the first quarter of 2024 is likely a price catch-up effect caused by the surge in epidemic-related costs at the beginning of the year. It is expected that as this price catch-up effect continues to manifest, the inflation rate of healthcare services for the full year of 2024 will remain at a high level Foreign Travel: Price increases are partly influenced by rising fuel prices and a weakening US dollar.

Goldman Sachs expects the annualized growth rate of foreign travel prices in the first quarter to rise to an average of 14.0% per month, with the monthly non-annualized core PCE inflation rate increasing by 2.9 basis points.

Why will PCE inflation slow down afterwards?

Goldman Sachs predicts that from the first quarter to the end of the year, the monthly consecutive growth rate of core PCE inflation will slow down from an average of 0.33% to 0.18%, mainly reflecting the slowdown in inflation for consumer electronics, financial services, housing, and healthcare.

Goldman Sachs states that year-end promotions for consumer electronics and software have ended, and prices are expected to decrease over the next nine months.

We expect its contribution to monthly core PCE inflation to shift from +4.2 basis points (non-annualized) in the first quarter to -2.0 basis points, with a monthly contribution shifting to -6.2 basis points, until the end of the year.

The recent sharp decline in US stocks is expected to slow down inflation in financial services. Goldman Sachs predicts that by the end of this year, the average monthly annualized growth rate will decrease from 10.1% in the first quarter to 3.8%, reducing its contribution to core PCE from 6.7 basis points (non-annualized) to 2.6 basis points, with a monthly contribution decreasing to -4.1 basis points.

Goldman Sachs believes that the early-year price increases in healthcare services have ended, but prices still have significant support for the remainder of this year.

Goldman Sachs predicts that by the end of this year, the average monthly annualized growth rate of healthcare prices will slow down from 4.1% in the first quarter to 3.2%, about 0.6 percentage points higher than the second half of 2023.

This will reduce its contribution to core PCE from 6.3 basis points (non-annualized) in the first quarter to 4.9 basis points at the end of the year, with a monthly contribution decreasing to -1.4 basis points.

The recent strength of the US dollar is expected to put pressure on foreign travel prices, with Goldman Sachs predicting the contribution to core PCE to decrease from +1.4 basis points (non-annualized) in the first quarter to +0.4 basis points for the remainder of this year, with a monthly contribution decreasing to -1.0 basis points.

Finally, Goldman Sachs expects housing to be a continued source of deflationary pressure this year and next.

The narrowing gap between new and existing tenant rents, along with the positive outlook for rental growth for new tenants, suggests that rents are expected to recover to pre-pandemic levels later this year.

Meanwhile, the ongoing catch-up space implies that housing service prices may continue to decline for the remainder of this year and in the future.