August PCE Inflation Eases Fed Rate Hike Pressure
Core PCE inflation cooled to 3.0% annually in August, below forecasts, as GDP was revised upward. Markets now see a higher probability the Federal Reserve will hold rates steady in October.
The Federal Reserve's preferred inflation gauge cooled in August, reducing immediate pressure for another interest rate hike. The core Personal Consumption Expenditures price index rose 0.2% for the month, putting the annual rate at 3.0%, below economist forecasts of 3.3%. The headline PCE index increased 0.3% in August and 3.4% from a year ago.
A methodological revision by the Bureau of Economic Analysis for measuring legal services, software, computer accessories, and portfolio management lowered the core inflation reading for July by 0.36 percentage points. Economists had forecast monthly and core annual increases of 0.3% and 3.3%, respectively.
Market reaction and Fed outlook
Market expectations for a Federal Reserve rate hike shifted significantly following the data release. The probability of the Fed holding its benchmark rate steady at the October meeting jumped to 60.7%, up from 49.1% the previous day, according to the CME Group's FedWatch tool. Traders now price the next potential increase for December.
Federal Reserve Bank of New York President John Williams stated there is no need for urgency, giving policymakers time to gather more information. He added that he still thinks another hike may be appropriate later this year. David Russell, global head of market strategy at TradeStation, said, "This is good news for investors worried about the recent surge in bond yields, and it bolsters the case for not hiking in October." He also noted the August data is relatively old and does not reflect this month's surge in diesel prices.
GDP and income snapshot
Broader economic data provided mixed signals. Second-quarter gross domestic product was revised upward to a 2.2% annualized rate from a prior estimate of 1.5%. Real final sales to private domestic purchasers increased 4.6%, an upward revision of 0.4 percentage point.
Personal income and spending figures for August showed a divergence. Income rose 0.2%, below the consensus forecast of 0.4%, while spending increased 0.9%, slightly above the expected 0.8%.
External factors and forward curve
Energy costs drove much of the August price rise, with gasoline jumping 4.4% and transportation services accelerating by 1.4%. Fuel prices have continued to rise in September, and persistent tensions between the U.S. and Iran have kept oil and gas prices elevated, making the August inflation snapshot less indicative of current conditions.
The yield on the 30-year U.S. Treasury bond rose to around 5.65%. Stock market futures gained ground following the inflation report while Treasury yields were negative. The market is using the data to shape its outlook on the forward curve for future interest rates, with traders now pricing in a potential rate hike in December.
