PCE Inflation Holds at 3.7%, Delaying Fed Rate Cut Hopes

The Fed's preferred inflation gauge held at 3.7% annually in July, topping consensus by a tenth of a point as energy costs kept price pressures elevated and delayed rate-cut expectations.

"Inflation could be extended the longer there's back and forth in the Canada tariff war," Minneapolis Fed President Neel Kashkari said, as trade frictions add another layer of uncertainty to the central bank's inflation outlook.

Core PCE, which strips food and energy, rose 0.2% month over month and 3.3% year over year, matching analyst forecasts. Consumer spending increased $36.3 billion, or 0.2%, in July, with a $86.2 billion gain in services partly offset by a $49.9 billion decline in goods. Personal income climbed $115.1 billion, or 0.4%, while the personal saving rate came in at 3.0%.

The data lands a week before the Fed's September 17-18 policy meeting, with futures markets pricing a 38% chance of a quarter-point hike, down from 55% a month ago. Fed Chair Kevin Warsh speaks at the Jackson Hole Symposium on Friday, where he is expected to address the central bank's policy path without committing to forward guidance.

The headline reading came in above the 3.6% annual pace economists polled by FactSet had projected, while the monthly gain of 0.2% also exceeded the 0.1% Dow Jones consensus. The persistence of inflation well above the Fed's 2% target suggests the central bank has limited room to ease policy even as the labor market shows signs of cooling.

Hike Odds Drop to 38% Ahead of Jackson Hole

Futures markets have repriced the odds of a September hike down from 55% a month ago to 38%, according to the CME FedWatch Tool. The central bank's reluctance to provide forward guidance has contributed to increased market volatility, strategists at DBS Bank noted, with investors uncertain about how much tightening the Fed is prepared to tolerate through long-term yields.

The US dollar has weakened 0.75% this month, with the Dollar Index more than 2.5% below its late-July peak, as traders priced in a more dovish Fed. OCBC analysts said the greenback needs Warsh and other Fed officials to "push back against emerging debasement concerns and reinforce their commitment to returning inflation to the Fed's 2% target" to find significant support. EUR/USD has rallied 2.5% this month to near three-month highs around 1.1650, while gold trades below $4,650 as investors weigh the rate outlook.

Real Spending Flat as Price Pressures Bite

Consumer spending rose $36.3 billion, or 0.2%, in nominal terms, but real PCE was essentially flat, rising less than 0.1%. The divergence reflects the drag from higher prices, which are absorbing a larger share of household budgets. Services spending climbed $86.2 billion, while goods spending fell $49.9 billion.

Personal income increased $115.1 billion, or 0.4%, driven by gains in compensation, government social benefits, and personal income receipts on assets. Disposable personal income rose 0.5%, and the saving rate held at 3.0%, leaving households with limited buffer against further price increases.

Core PCE peaked at 3.4% year over year in May before easing to 3.3%, but the plateau above the Fed's 2% target suggests the central bank has limited room to ease. If the current level persists, the Fed may need to hold rates higher for longer, which would pressure equity valuations in rate-sensitive sectors and keep Treasury yields elevated.

The next BEA release covering August personal income and outlays is scheduled for September 30, after the Fed's September meeting. A benign reading would reinforce the case for a hold, while another upside surprise could revive concerns about sticky inflation and push the Fed toward additional tightening.

This article is for informational purposes only and does not constitute investment advice.