July PCE Review- Where it pushes the 25 vs 50 bps debate
The July PCE report showed modest increases in both headline and core inflation, with the all-item PCE price index rising 0.2% month-over-month and 2.5% year-over-year, in line with expectations. Core PCE, which excludes food and energy, also increased by 0.2% month-over-month and 2.6% year-over-year, slightly below the consensus estimate of 2.7%. This data suggests that inflation pressures are continuing to ease, providing some reassurance that the Federal Reserve's efforts to curb inflation are bearing fruit, albeit gradually.
The report highlighted that core prices, excluding housing, saw only a 0.1% month-over-month increase, indicating that while overall inflation is stabilizing, certain components like shelter remain sticky, with housing costs rising by 0.4% in July. Personal income rose by 0.3%, slightly above expectations, while consumer spending increased by 0.5%, in line with forecasts. However, the personal savings rate fell to 2.9%, the lowest since June 2022, suggesting that consumers are dipping into savings to maintain spending levels.
Given the softer-than-expected core inflation figures, the report bolsters the argument for a more measured approach by the Federal Reserve in its upcoming September meeting. Market expectations have shifted slightly towards a 25 basis point rate cut, as opposed to a more aggressive 50 basis point reduction. The data supports the view that the Fed may now pivot from its intense focus on reducing inflation to a more balanced approach that also considers the slowing labor market.
Fed officials, including Chair Jerome Powell, have expressed confidence that inflation is gradually returning to the Fed's 2% target. With inflation showing signs of stabilization, the Fed is likely to proceed cautiously, particularly as the labor market, while still relatively strong, shows signs of cooling. The next key data point will be the August nonfarm payrolls report, which will provide further insight into the health of the job market and could influence the Fed's final decision on rates.
In terms of market reaction, there was little immediate response to the PCE data, with equity futures pointing to a slightly higher open and Treasury yields edging up. Investors seem to be interpreting the report as a sign of steady progress on inflation, which reduces the urgency for the Fed to act aggressively. As the Fed meeting approaches, all eyes will be on upcoming economic data to see if this trend continues, potentially solidifying the case for a smaller, 25 basis point rate cut in September.