65%! That’s the average global economic output that households’ consumption contributes to economic output. Since inflation tends to go hand-in-hand with demand, most monetary policy decisions are centered around, ensuring a sustainable inflation rate in the economy.
You see, a manageable inflation growth can be the difference between a healthy economic growth, overheating heating economy, or a stagnating one. Therefore, understanding the factors that contribute to the overall inflation rate cannot just be the preserve for governments and central banks. This information can prove useful to forex traders as well.
Understanding PCE Price Index
To understand the PCE price index, we first need to understand PCE itself. Personal consumption expenditures measures how much households spend in an economy within a particular period. The consumption tracked by PCE includes consumption on durable goods, nondurable goods, and services.
Durable goods are consumer items that last for more than three years, such as cars and household appliances. On the other hand, nondurable goods include perishable consumer items like foodstuffs. The services, in this case, includes any services that might be sought by households ranging from professional services such as legal services to home-care services.
How PCE is Measured?
As we have already established, most of the production within an economy is meant for household consumption. The government can be able to deduce the PCE using the GDP data. Firstly, the local manufacturers’ shipment data is used to estimate the amount designated for household consumption.
Next, deducing the consumption of services, the government uses data on revenue collected for utilities, professional services commissions, and receipts for services rendered. Net imports (i.e., imports fewer exports) are added, and the national inventory changes are subtracted. The resulting data represents the amount of consumption by households within the economy.
Purpose of the PCE Data
While PCE can be used to show the growth of aggregate demand and economic growth, it is also used to compute the PCE price index. The PCE price index is also known as PCE inflation. It measures the changes in the price of household goods and services over a specific period.
After obtaining the PCE data, it is converted into prices paid by the households. The conversion is achieved using the consumer price index. Note that the PCE price index incorporates the taxes paid, profit margins of the producers and suppliers, and the cost of delivery. Thus, the PCE price index is a broad measure.
Difference between PCE Price Index and the CPI
It is worth noting that both these indexes are used to measure the rate of inflation in an economy. However, the most notable difference between them is that the PCE data is derived from the GDP data and businesses’ surveys. CPI data, on the other hand, is arrived at from surveys conducted on the households. Based on their different sources, the PCE data covers a lot of the items that households on which household spend. Therefore, the PCE price index data tends to be smoothened since a significant change in the price of a single item won’t grossly distort the index.
Source: St. Louis FRED
Using PCE Data in Analysis
The PCE price index can be used as a broad measure of inflation within an economy. While CPI is a good measure of inflation, the PCE price index tracks the price changes in more goods consumed by households. More so, the price changes reflected in the PCE price index represents the cost of production, taxes, and the cost of delivering the goods and services to the consumers. Furthermore, using the core PCE price index eliminates the volatile prices of a few items, such as gasoline prices will distort the index reading compared to CPI.
Source: St. Louis FRED
As a measure of economic growth, the PCE data is unrivaled. Seeing that the PCE data itself is derived from the GDP figures, the changes in the immediate consumption by households can be used to track how the economy will grow in the short term. To properly gauge whether the increased expenditure on consumption is real or a result of inflation, the following factors are considered.
Firstly, is the quantity purchased by households increasing with little change in the prices? Are the households buying higher quantities at higher or lower prices? Are households spending more money to purchase lesser quantities? Since the PCE price index tracks broad changes in consumption, these factors will help determine whether the economy is growing or merely the prices of goods and services changing.
The changes in the PCE data can be used to show the conditions in the labor market. Household consumption represents the aggregate demand in the economy. Thus, when PCE increases, it shows that demand is increasing. The trickle-down effects of increased aggregate demand increase in the aggregate supply and expansion in production. The increased production implies that more labor will be needed hence lower unemployment levels and improved welfare. Conversely, decreasing PCE can be a leading indicator of worsening labor market conditions.
Impact on Currency
A straight line can be drawn from PCE to inflation to monetary policies. Demand is one of the primary factors behind inflation. In the forex market, the changes in PCE and PCE price index can be used to predict likely monetary policies. Note that most central banks use the PCE price index to set the target rate of inflation.
A continuous increase in PCE and rising PCE price index shows that inflation in the economy is increasing. Central banks are likely to implement contractionary monetary policies such as hiking interest rates to avoid an overheating economy. The contractionary policies make the currency appreciate relative to others.
Conversely, decreasing PCE levels accompanied by a lower PCE price index may be an indicator of a stagnating economy. Central banks are more likely to lower interest rates to stimulate the economy. Such expansionary policies make the currency depreciate relative to others.
Sources of Data
In the US, the Bureau of Economic Analysis publishes the Personal Income and Outlays report monthly. This report contains the PCE and PCE price index data. St. Louis FRED has an in-depth and historical analysis of the US’s PCE and PCE price index data.
How PCE Price Index Data Release Affects Forex Price Charts
In the US, the most recent publication of the PCE price index data was on October 1, 2020, at 8.30 AM EST and accessed at Investing.com.
Below is a screengrab from Investing.com. We can see that moderate volatility is expected in the forex market when the PCE price index data is released.
In August 2020, the core PCE price index increased by 1.6% from 1.4% in July 2020. This increase is expected to have a positive impact on the USD.
EUR/USD: Before PCE Price Index Release on October 1, 2020, Just Before 8.30 AM GMT
The EUR/USD pair was trading in a steady uptrend before the publication of the PCE price index data. The 20-period MA was steeply rising with candles forming above it.
EUR/USD: After PCE Price Index Release on October 1, 2020, at 8.30 AM GMT
After the release of the PCE price index data, the pair formed a 5-minute ‘Doji’ candle. As expected, the stronger USD made the pair adopt a bearish stance with the 20-period MA steeply falling and candles crossing over below it.
As observed, the PCE price index data release has a significant effect on the forex price action. Perhaps the relevance of the PCE data comes from the fact that the US Federal Reserve uses it to set the target inflation.