The Federal Reserve’s favorite inflation gauge came in softer than expected in August, and markets reacted the way they always do when inflation surprises to the downside: with relief. The headline personal consumption expenditures price index rose 0.3% in August, below the 0.4% economists had forecast, and over the past 12 months inflation advanced 3.4%, down from the 3.7% pace economists expected, according to Commerce Department data reported by Reuters, the Wall Street Journal, and Investopedia.
Strip out food and energy and the picture looks better still. Core PCE rose 0.2% in August, below the 0.3% consensus, and the annual rate held at 3.0%, a full three-tenths below the 3.3% forecast, Reuters and Investopedia reported. That is the measure Fed officials watch most closely, and it is now running at its softest pace in the revised data. The Bureau of Economic Analysis also revised July’s numbers lower: core PCE’s July gain was cut to 0.1% from 0.2%, and headline PCE’s July gain to 0.1% from the previously reported 0.2%.
There is an asterisk worth understanding, and it is one this site flagged before the release. The BEA changed its methodology for calculating prices for software and accessories, portfolio management fees, and legal services, and applied the change retroactively to data going back to 2021, Reuters reported. The Journal described it as a fix for three mismeasured categories, legal services, investment services, and computer software. That rewrite is why July’s headline inflation now reads 3.4% instead of the 3.7% originally reported. The numbers are softer partly because prices genuinely cooled, and partly because the ruler changed. Both facts matter.
The market’s verdict was immediate. Stock futures jumped: Dow futures rose 0.4%, S&P 500 futures added 0.4%, and Nasdaq 100 futures climbed 0.3%, Barron’s reported. The 10-year Treasury yield fell to about 5.23% and the 2-year to about 4.86%. Traders now see roughly a coin flip, around 47% to 51%, that the Fed raises rates at its late-October meeting, down from more than 70% on Monday, according to CME FedWatch data cited by Investopedia and Reuters. New York Fed President John Williams helped the dovish turn on Tuesday, saying he saw “no urgency” for further action, Reuters reported. The Fed raised its benchmark rate to a range of 3.75% to 4.00% in September, its first hike in three years, and flagged that more increases were possible.
The morning brought a double dose of good news, because growth surprised to the upside too. The Commerce Department revised second-quarter GDP growth up to 2.2% from the 1.5% previously reported, with consumer spending and investment both stronger than thought, the Journal and Investor’s Business Daily reported. A key measure of underlying demand, real final sales to private domestic purchasers, was revised up to 4.6%. And ADP reported that private payrolls rose by 90,000 in September, beating the 70,000 economists expected and up from 38,000 in August, Investor’s Business Daily reported.
Look closer at the household picture and the glow dims a little. Personal income growth missed expectations and real disposable income was flat, even as consumer spending surged and the savings rate fell, Seeking Alpha reported. Spending is running hot while the income behind it is not, which is the kind of pattern that cannot continue forever. For now, though, the combination of cooling inflation and resilient growth is exactly the soft-landing script markets have been hoping for.
What happens next is in the Fed’s hands, literally. At least four Fed officials speak today, including Minneapolis Fed President Neel Kashkari, Reuters reported, and their first public reactions to this report will shape the debate into the October meeting. Both core and headline inflation remain well above the Fed’s 2% target, so today’s relief is not the same as victory. But for one morning, the number moved in the right direction, and the market noticed.
