Fed’s Favorite Inflation Gauge Lands Tomorrow: Will Hot PCE Data Torch Hopes for a September Rate Cut?

Markets head into Friday’s Personal Consumption Expenditures (PCE) release with a mix of optimism and caution. Inflation has shown signs of firming in recent months, as reflected in July’s consumer price index (CPI) and producer price index (PPI), but the message from Federal Reserve Chair Jerome Powell at Jackson Hole last week was dovish enough to leave markets expecting a 25-basis point rate cut at the September 17 FOMC meeting. According to CME’s FedWatch tool, futures markets are pricing in about an 85% chance of that cut. Against that backdrop, tomorrow’s PCE release is unlikely to surprise in a big way—most of the components are already known—but it still represents one of the final major inflation data points the Fed will see before its September policy decision. If the figures run materially hot, particularly more than 20 basis points above consensus, it could dent the prevailing market narrative of a September cut.

Economists are looking for headline PCE to rise 0.2% in July, a moderation from June’s 0.3% monthly increase, while the year-over-year rate is expected to remain steady at 2.6%. Core PCE, which strips out food and energy and is the Fed’s preferred inflation gauge, is forecast to climb 0.3% month-over-month and 2.9% year-over-year. That would mark a slight acceleration from June’s 2.8% core reading and represent the highest annual pace since February. Powell last week essentially previewed these figures, noting that 12-month headline PCE inflation was running at 2.6% in July and core at 2.9%, and his messaging suggested that the Fed sees enough progress on inflation and sufficient downside risks to growth to justify easing in September.

The broader context is that inflation data has been running warmer than expected this summer. July CPI showed a steady 2.7% headline gain but an uptick in core to 3.1%, the fastest increase since January. Producer prices were also firmer than anticipated, with the PPI up 3.3% year-over-year. Tariff pressures are flowing through the system, particularly into goods prices, and economists have also flagged hotter services inflation in the PPI as a potential sign that underlying pressures are broadening beyond tariff-sensitive categories. That makes tomorrow’s PCE report all the more important: a confirmation of moderate increases could soothe markets, while another upside surprise might challenge the Fed’s easing trajectory.

The Fed’s target is 2% inflation, and it has not been met in over four years. With headline PCE stuck above 2.5% and core moving closer to 3%, some economists argue the Fed is easing into conditions that are not yet consistent with price stability. Tariffs imposed by the Trump administration are adding to cost pressures, as businesses pass import costs to consumers. At the same time, growth momentum is softening and the labor market has cooled, which helps explain Powell’s emphasis on jobs over inflation at Jackson Hole. He underscored that he was “less worried about inflation” and “more worried about jobs,” suggesting that even with inflation still elevated, the Fed believes it can and should cut rates to support demand.

The July PCE release will also bring personal income and spending data, which economists expect to rise 0.5% apiece. That would be an acceleration from June, when income rose 0.3% and spending 0.3%. Some of the July strength likely reflects a jump in auto sales, and many analysts expect consumer spending to cool into the fall as higher prices and slower wage growth sap momentum. Economists at Wells Fargo noted that “consumers continue to spend but they have grown choosier,” while BMO’s Jennifer Lee said she is watching wages and salaries closely to see if households have “less gas in the spending tank.” These dynamics will matter for the Fed’s growth outlook just as much as the inflation readings.

Markets are clear in their base case: a 25-basis point cut is coming in September unless the PCE data prints well above consensus. Even a 0.4% core monthly gain—just 10 basis points above expectations—would raise eyebrows, but most strategists suggest that only a surge toward 3% or higher in year-over-year core would significantly alter expectations. Avery Shenfeld of CIBC remarked that without the political overlay, the numbers would simply be a reminder that inflation remains above target and not exactly begging for a rate cut, but the Fed is leaning toward easing regardless. Comerica’s Bill Adams added that tariff-related inflation is already flowing through the economy, but Powell’s focus on the labor market means he is unlikely to be derailed by one month of hotter-than-expected data.

In sum, Friday’s PCE data is expected to show inflation running above the Fed’s 2% goal but not so hot as to derail the widely anticipated September rate cut. Headline PCE should hold at 2.6% year-over-year, while core climbs modestly to 2.9%. Monthly gains of 0.2% and 0.3%, respectively, are consistent with the narrative Powell outlined at Jackson Hole. The risk is that an upside surprise could shave odds of a September cut from the current 85%, but unless the data is materially hotter, markets are likely to stay confident in an easing move. That makes this release less about whether the Fed will cut next month, and more about how much room it leaves for additional cuts later this year.