Fed's Preferred Inflation Gauge Cools, Potentially Delaying Rate Hike to December
August core PCE data shows a slower rise, potentially giving the Federal Reserve room to hold off on further interest rate increases.
The Federal Reserve's preferred inflation measure, the core Personal Consumption Expenditures (PCE) price index, registered a more moderate increase in August than anticipated, a development that could push a potential interest rate hike to December. The Bureau of Economic Analysis reported that the core PCE index, which excludes volatile food and energy prices, rose 0.2% for the month, equating to a 3% annual rate. This figure fell below economists' expectations of a 0.3% monthly increase and a 3.3% annual rate.
Overall PCE also showed a slowdown, increasing by 0.3% monthly and 3.4% annually, which was also below projections of a 3.7% yearly rise. Analysts note that the Bureau of Economic Analysis implemented methodological adjustments this month for measuring prices of services like legal advice, software, and portfolio management, making it challenging to fully distinguish between actual price softening and the impact of these data tweaks.
The Federal Reserve will review two additional inflation reports, the Consumer Price Index and Producer Price Index for September, before its next policy meeting on October 28. However, officials tend to favor the core PCE index as a more stable indicator of long-term inflation trends, as it filters out temporary price shocks.
Despite the cooler inflation reading, the core PCE remains significantly above the Fed's 2% target. Concurrently, other economic data released on Wednesday indicated resilience in the job market and overall economic growth. Chris Zaccarelli, chief investment officer at Northlight Asset Management, commented that the mixed economic signals suggest the Fed's recent rate hike was justified, but improved inflation data could allow for a pause or a less aggressive increase in rates at future meetings.
Markets reacted positively to the economic releases, with stocks experiencing modest gains. The Dow Jones Industrial Average rose by 95 points, or 0.2%, the S&P 500 increased by 0.7%, and the Nasdaq saw a 1.1% jump. The likelihood of a quarter-point rate hike at the Fed's October meeting decreased to 37% following the data release. The market consensus largely anticipates a second rate hike in December, with investors suggesting that the latest inflation figures provide the Fed with more flexibility.
Energy prices were a primary driver of the monthly inflation increase, with gasoline prices rising 4.4% in August due to supply disruptions linked to the conflict in the Middle East. Transportation services also contributed to the rise, increasing by 1.4%. The broader energy goods and services sector saw a 2.3% increase.
A separate report on Gross Domestic Product (GDP) revealed that the economy expanded at a 2.2% annualized pace in the second quarter, an upward revision from the initial estimate of 1.5%. This growth was attributed to increased consumer and government spending, as well as higher business investment. Real final sales to private domestic purchasers, a key metric for underlying demand, surged by 4.6%.
Furthermore, the ADP National Employment Report indicated that private sector employment grew by 90,000 jobs in September, an increase from the revised 36,000 jobs added in August. This sustained job growth, alongside a steadily growing economy, keeps the Federal Reserve's focus on managing inflation.