Softer PCE Inflation Reframes Fed Rate Path
TREE NEWS reports: US core PCE inflation for August came in below expectations, prompting Goldman Sachs to push its forecast for the Federal Reserve’s second rate hike of the year from October to December. The core PCE price index rose 0.25% month over month and 3.01% year over year, undershooting consensus estimates. The headline PCE price index held steady at 3.4% year over year, while the monthly print accelerated to 0.3%.
Goldman Sachs economists led by Jan Hatzius wrote that the data, combined with comments from New York Fed President John Williams a day earlier, make an October hike unlikely. The team now sees the second hike in December and believes there is a strong chance the FOMC ultimately concludes no further tightening is needed. Goldman projects fourth-quarter core PCE inflation at 3.0% year over year, well below the FOMC’s median projection of 3.4%.
Market Pricing Shifts, but Not Decisively
Futures markets adjusted modestly. The CME FedWatch Tool showed the probability of an October hike at roughly 39%, down from about 45% before the release, while the odds of a December move climbed to 90%. Treasury yields initially dipped on the news, with the 2-year yield falling from 4.887% to around 4.864%, but it quickly retraced the entire move and resumed climbing. The 10-year yield continued to push higher, suggesting investors are not yet convinced the inflation fight is over.
Analysts remain divided. Capital Economics’ Stephen Brown called the core price pressures slightly softer than feared, supporting a October pause. He noted that methodological revisions to PCE data lowered core inflation by about 0.3 percentage points, and downward revisions to June and July brought the three-month annualized core rate down to 2%. BMO’s Sal Guatieri was more cautious, pointing out that the share of PCE components rising more than 3% annualized only fell from 54% to 51% — still far above normal levels and hardly evidence of a meaningful improvement in the underlying trend.
Growth Data Complicate the Picture
Wednesday’s data also showed the US economy is far from cooling. Second-quarter GDP growth was revised sharply higher to 2.2% annualized from 1.5%, with both consumer spending and investment revised up. Real final sales to private domestic purchasers, a key measure of underlying demand, was revised to 4.6%. The investment upgrade highlights the role of AI infrastructure buildout in supporting growth, while stronger consumer spending suggests households remain in solid financial shape amid a resilient job market and a strong stock market.
August consumer spending rose 0.9% month over month, partly driven by higher gasoline station spending as oil prices climbed. Income growth slowed slightly to 0.2% from 0.3%. The combination of softer inflation but robust growth means the Fed faces a tricky balancing act: price pressures are easing, but not fast enough to declare victory, and the economy is running hot enough to keep the option of another hike alive.
What It Means for Investors
- Rates: The initial Treasury rally faded quickly, showing bond markets are not pricing in a dovish pivot. The 10-year yield’s continued rise suggests term premium and growth expectations are still pushing yields higher.
- Equities: Softer inflation is a near-term positive for stocks, especially rate-sensitive growth names, but the strong GDP revision keeps the “higher-for-longer” risk alive. Earnings growth will need to carry the market if multiple expansion stalls.
- Currencies: A delayed but still-likely hike should keep the dollar supported against low-yielding currencies, though the greenback may struggle for direction until the December meeting comes into clearer focus.
- Crypto: Digital assets remain sensitive to real yields and liquidity expectations. A December hike that may be the last would be less bearish than an October move, but until the Fed signals a pause, crypto is likely to trade range-bound with macro headlines.
Investors should watch upcoming PPI, CPI and employment data for confirmation of whether the disinflation trend is reasserting itself. The December FOMC meeting is now the key event, but the possibility that the Fed is done hiking altogether is a scenario markets have yet to fully price.
