TD Securities lifted its August core PCE forecast after PCE-linked components in the August PPI release came in firmer than expected. The bank now sees core PCE inflation at 0.24% month on month and 3.3% year on year, while headline PCE is pencilled in at 0.33% m/m and 3.8% y/y. A separate market-based core PCE gauge is projected at 0.18% m/m, implying a modest acceleration from July.
The outlook is framed by data and technical adjustments rather than discretionary judgement. The forecast path, alongside the Fed’s September decision, is tied to the forthcoming CPI report. TD also pointed to uncertainty around BEA methodology changes affecting portfolio management calculations, expecting year-on-year inflation to be revised down over time, while the near-term monthly profile could print a touch firmer.
Near-Term Inflation Surprises and Trading Volatility
With the August inflation data coming in hotter than expected due to recent producer price inputs, we are facing a sharper near-term inflation profile than the market anticipated. We now expect core PCE to rise to 0.24% month-over-month, pushing the year-over-year figure to 3.3%, while headline PCE could hit 3.8%. Derivative traders should immediately prepare for heightened volatility as we approach tomorrow’s crucial CPI release.
Given these stronger near-term inflation estimates, we recommend derivative traders look closely at short-term interest rate options and Secured Overnight Financing Rate (SOFR) futures. Historically, when core PCE prints higher than market consensus by even 0.1%, we see rapid repricing in Federal Reserve rate expectations, often causing a 10 to 15 basis point spike in short-term Treasury yields. Protecting against a hawkish shift in the upcoming Fed decision is now our primary trading priority.
Managing Portfolio Risk Amid BEA Revisions
While the market might be overselling the severity of recent revisions, we must also account for the Bureau of Economic Analysis’s new calculation methods. Over the coming weeks, we expect downward adjustments to the longer-term year-over-year trend, which could create a prime buying opportunity for call options on Treasury futures once the initial monthly inflation panic subsides. Spreading our risk across October and November contracts will help us navigate these conflicting monthly and yearly signals.
Looking back at similar inflationary blips, initial market overreactions to monthly PPI and CPI spikes usually normalize within three weeks as broader economic cooling trends persist. Current futures pricing indicates that even a slight upside surprise tomorrow could drop the implied probability of a near-term rate cut down significantly, shifting it from a highly anticipated move to a coin toss. We advise positioning for this volatility by buying straddles on major equity indexes and shorting short-duration bond futures ahead of the weekend.
