July PCE reading bolsters outlook for Fed rate cut

Fed Chairman Jerome Powell
Federal Reserve chair Jerome Powell said in a speech in Jackson Hole, Wyo., in August that inflation has been cooling to the point where the central bank is willing to cut the Federal Funds Rate for the first time in four years.
Bloomberg News

Inflation continued to show signs of easing in the Federal Reserve's preferred pricing index, setting the central bank up to cut interest rates for the first time in more than four years next month. 

The personal consumption expenditures, or PCE, index for July came in at 2.5% over the same point last year, according to a report released by the Bureau of Economic Analysis on Friday. Core PCE, which factors out food and energy, was up 2.6% year over year. Prices rose 0.2% from June in both indexes.

Both the headline and core figures mirrored June's readings of 2.5% and 2.6%, respectively. Annualized core PCE inflation has now held steady or fallen every month for the past 15 months. Fed Chair Jerome Powell has said this downward trajectory has bolstered his confidence that inflation is on a "sustainable path" to the Fed's 2% target.

During his speech in Jackson Hole, Wyoming, earlier this month, Powell said the inflation picture has improved to the point that the Fed could begin easing monetary policy in the near future.

"The time has come for policy to adjust," he said. "The direction of travel is clear, and the timing and pace of rate cuts will depend on incoming data, the evolving outlook, and the balance of risks."

The Fed's target range for the federal funds rate has been between 5.25% and 5.5% since July 2023. During the past year, Powell and other members of the Federal Open Market Committee have said the decision to begin easing monetary policy will be based on economic data and they would rather risk waiting slightly too long to begin cutting rates than move too early.

Federal Reserve Bank of Atlanta President Raphael Bostic, a current voting member of the FOMC, reiterated that point earlier this week during public remarks in Georgia.

"I don't want us to be in a situation where we cut and then we have to raise rates again," Bostic said Wednesday. "So, if I'm going to err on one side, it's going to be waiting longer just to make sure that we don't have that up and down."

Earlier this month, Fed Gov. Michelle Bowman, who has positioned herself as one of the most inflation-sensitive members of the FOMC, said she was not quite ready to sign off on a rate cut, noting that she sees upside risks to inflation

"I continue to view inflation as somewhat elevated," Bowman said on Aug. 20. "And with some upside risks to inflation, I still see the need to pay close attention to the price-stability side of our mandate while watching for risks of a material weakening in the labor market."

Derek Tang, co-founder of Monetary Policy Analytics, said Friday's PCE report should give "reassurance" to the majority of voting members who were already leaning toward backing a rate cut in September. 

For policymakers still debating the cadence of future rate cuts, Tang said this latest reading could give them "more reason not to skip in November" — though he noted that there are still important data developments ahead.

"The main event is still the jobs report next Friday, since their sense of urgency depends on the depth of labor market softening," Tang said. "While some seem already on board with a 50 in September, most are going to stick with starting with 25 or a string of 25s until something nudges them to go harder."

Market participants have been factoring in a rate cut of at least a quarter percentage point since the Fed's last FOMC meeting in July, according to CME's FedWatch tool, which tracks expectations through 30-day Fed Funds futures trading. As of Friday morning, two-thirds of the contracts priced in a 25-basis-point cut while the rest expected a half-percentage-point drop. 

The favorable PCE inflation reading was broadly expected. Other key indexes from July had already shown positive developments in inflation, including the Consumer Price Index, which was up 2.9% over last year, and the Producer Price Index — which explores demand-side pricing — up just 2.2%.

Joe Davis, global chief economist for Vanguard, said the report has not changed the investment advisory's outlook on monetary policy. In an analyst note, he said he expects rate cuts in September and December. 

"Chair Powell has signaled an increasing focus on labor market conditions as the impetus for near-term policy," Davis said. "With goods prices under control, services prices should continue to moderate through the end of this year as the labor market comes into better balance."

All eyes now turn toward the labor market with two key reports due out next week. First, the Job Openings and Labor Turnover Survey, or JOLTS, report from July, which is set for release on Wednesday, then the Employment Situation report for August, which is set to release on Friday. 

During his Jackson Hole speech, Powell said the full employment side of the Fed's dual mandate has overtaken price stability as the more pressing concern facing the economy.

"The upside risks to inflation have diminished and the downside risks to employment have increased," he said. "As we highlighted in our last FOMC statement, we are attentive to the risks to both sides of our dual mandate."

There will also be another CPI release on Sept. 11, one week before the next rate-setting meeting. While core PCE is the Fed's preferred measure, the FOMC takes a wide range of readings into consideration.

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