Federal Reserve’s September Rate Cut Bets Rise Despite Sticky PCE Inflation

The Federal Reserve finds itself at a critical juncture, navigating persistent inflationary pressures while considering the economic implications of a potential interest rate adjustment next month. Recent data from the Commerce Department’s Personal Consumption Expenditures (PCE) index, the central bank’s preferred inflation gauge, reveals a complex landscape: inflation remains elevated, yet signals from the labor market and the impact of the Trump administration’s tariffs are influencing the Fed’s delicate balancing act.

• The Federal Reserve is balancing persistent inflation with potential interest rate adjustments.
• The PCE index, the Fed’s preferred inflation gauge, indicates elevated inflation.
• Both labor market signals and the impact of tariffs are influencing the Fed’s decisions.
• The core PCE index reached 2.9% annually in July, exceeding the Fed’s 2% target.

Detailed PCE Data Insights

In July, the headline PCE index registered a 0.2% increase month-over-month and held steady at 2.6% on a year-over-year basis, aligning with economists’ expectations. More critically, the core PCE index, which excludes volatile food and energy prices and is often viewed by policymakers as a more accurate indicator of underlying inflationary trends, rose 0.3% monthly and reached 2.9% annually. This marks its highest level since February, placing it notably above the Fed’s long-term target of 2% and underscoring the ongoing challenge of price stability.

Beyond the headline figures, the report offered a detailed look at sector-specific price movements. Prices for goods collectively increased by 0.5% year-over-year in July, with durable goods experiencing a 1.1% rise and nondurable goods increasing by a modest 0.2%. Services prices, a significant component of the economy, climbed 3.6% compared to the previous year, a slight acceleration from June’s 3.5% reading. Meanwhile, wages and salaries showed a robust rebound, increasing 0.6% from June, following a minimal 0.1% gain that month. The personal savings rate remained unchanged at 4.4% of disposable personal income.

Federal Reserve’s Stance and Challenges

Federal Reserve Chair Jerome Powell, in his address at Jackson Hole, articulated the central bank’s evolving perspective. He characterized the labor market as being in a “curious kind of balance” due to a marked deceleration in both the supply of and demand for workers. While acknowledging increasing downside risks to employment, Powell highlighted the persistent challenge posed by upside inflation risks, particularly those stemming from the Trump administration’s tariffs. He noted that the “effects of tariffs on consumer prices are now clearly visible” and questioned whether these price increases would “materially raise the risk of an ongoing inflation problem” or represent a more transient, one-time shift in price levels.

Market Expectations and Policy Outlook

The Federal Reserve’s dual mandate requires it to foster maximum employment and maintain price stability, targeting 2% inflation. Recent economic data, including a weaker July jobs report, has amplified market speculation regarding a September rate cut. The in-line PCE inflation report, while not definitively resolving the inflation outlook, has kept the focus squarely on labor market conditions as the primary driver for a potential policy shift.

Economists are keenly observing these dynamics. Ellen Zentner, chief economic strategist at Morgan Stanley Wealth Management, noted that while the Fed has opened the door to rate cuts, the extent of such adjustments hinges on whether labor market weakness continues to outweigh rising inflation concerns. Similarly, Bret Kenwell, U.S. investment analyst at eToro, observed that while the PCE data maintains the possibility of a September rate cut, the broad-based rise in inflation across goods and services could constrain the Fed’s pace and aggressiveness in easing monetary policy.

Following the PCE report, market sentiment, as reflected by the CME FedWatch tool, indicated a slight increase in the probability of a 25-basis-point rate cut in September. The likelihood of such a reduction from the current federal funds target range of 4.25% to 4.5% rose from 86.7% to 87.2%, signaling growing market confidence in an impending policy adjustment despite the sticky inflation data.