The U.S. economy showed signs of cooling as fourth-quarter GDP growth was revised down to just 0.7%, while January's core inflation remained elevated at 3.1%. Treasury bonds rallied as investors interpreted the mixed data as supporting the case for Federal Reserve rate cuts later this year.
The Personal Consumption Expenditures (PCE) price index, the Fed's preferred inflation measure, continues running well above the central bank's 2% target. This persistent inflation has complicated the Fed's monetary policy decisions, as officials balance growth concerns against price stability mandates.
Core PCE inflation hit 3.1% year-over-year in January, matching economist expectations but remaining stubbornly high. The headline PCE reading came in at 2.9%, while the downward GDP revision reflects weaker consumer spending and business investment in the final quarter of 2023.
Bond traders have nearly fully priced in at least one Fed rate cut this year, reflecting expectations that slowing growth will eventually force the central bank's hand. The combination of sticky inflation and weakening economic momentum presents a challenging backdrop for Fed policymakers.
Geopolitical tensions, including ongoing Iran conflicts, threaten to push inflation even higher through energy price impacts, potentially limiting the Fed's flexibility on rate cuts.