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The Fed looks past its preferred inflation gauge

This is The Takeaway from today's Morning Brief, which you can sign up to receive in your inbox every morning along with:

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Not until 2026 will inflation fall to the sweet spot of 2%, according to the Fed’s latest projections. Since its release last week, the forecasts have spooked markets and cemented the idea that higher rates will stick around for longer.

But in this extended timeline, as the Fed adopts a more cautious posture, it won’t be persistent price increases that prompt central bankers to pounce, but insatiable American shoppers and an economy that stays too hot.

That’s not to say the next PCE reading, set to come in on Friday and expected to ring in at 3.5% annually, is no longer important. PCE, of course, is literally the measure of price stability.

But the Fed’s portfolio of worries has expanded to other factors that could interfere with its goal of reclaiming price stability — getting that PCE reading down and having it stay down over the longer term.

At the Fed presser last week, Chair Powell asked: “Is the heat that we see in GDP, is it really a threat to our ability to get back to 2% inflation? That's going to be the question.”

The Fed’s thinking stems from the potential that robust economic growth has to reinvigorate inflation over time, which would throw out of whack what central bankers hope is a rebalancing of the labor market.

Projections for fewer rate cuts next year placed the Fed’s fears in a different light: that the economy's refusal to slow down, even after getting whacked in the face by hike after hike, means more needs to be done to achieve the same level of inflation in the years ahead.

“They had expected a more significant impact on economic activity, and we just haven’t seen it yet,” said Michael Farr, chief market strategist for Hightower Advisors, and founder and CEO of Farr, Miller & Washington.

The Fed revised its GDP projections higher for the year. It was 1%. Now it’s 2.1%. And even next year, when officials forecast growth to slow substantially, the latest outlook is higher too, rising to 1.5% from 1.1%.

Still, the Fed has grown more confident that pricing pressures will improve. And while experts disagree over timing, the economy has not felt the full effects of higher borrowing costs, especially as elevated rates sap resilience over time.

But there's no doubt economic growth has defied expectations so far.

What will a partially un-struck Hollywood conjure up to follow on the success of “Barbenheimer”? Will there be some new version of Beyoncé’s roving money-generation machine? And what pop culture crossover will Taylor Swift and Travis Kelce birth?

The Fed’s most important inflation metric still matters. But with this amount of economic zeal and what appears to be a meaningful desire from the Fed to land the plane softly, investors will have to use a holistic view of economic data to determine not just where we are, but where we're going — just like Jay Powell.

Hamza Shaban is a reporter for Yahoo Finance covering markets and the economy. Follow Hamza on Twitter @hshaban.

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