PCE Preview- Data set to shape Fed's next move on rate cuts

The U.S. Department of Commerce is set to release the Personal Consumption Expenditures (PCE) price index, a critical inflation gauge for the Federal Reserve, on September 27th. Market consensus expects the headline PCE to decrease from 2.5% to 2.3% year-over-year (YoY) and from 0.2% to 0.1% month-over-month (MoM). The core PCE, which excludes food and energy, is anticipated to increase slightly from 2.6% to 2.7% YoY, while remaining flat at 0.2% MoM. This report will be closely watched as it may influence the Federal Reserve's upcoming decisions on interest rate cuts, especially given the recent dovish tone from some Fed officials.

Economists are particularly interested in how housing expenses, a significant component of the PCE, will influence the inflation data. Unexpected growth in housing costs has contributed to the recent uptick in core PCE, although inflation in other areas seems to be easing. The Federal Reserve is expected to weigh these figures heavily, especially as some officials, like Governor Waller, have noted that core PCE is running below the Fed's target on a four-month average annualized basis. This report could further support the case for additional rate cuts, especially if the inflation figures align with the Fed's projections.

The PCE differs from the Consumer Price Index (CPI) in several key ways, which is why the Federal Reserve prefers it as a measure of inflation. The PCE covers a broader range of goods and services, including those purchased on behalf of households by nonprofit institutions and the government, like healthcare services. It also uses a chain-weighting method that adjusts more dynamically to changes in consumer spending patterns, making it more responsive to shifts in the economy. The CPI, on the other hand, focuses specifically on out-of-pocket consumer expenditures and uses a fixed basket of goods, making it less flexible in capturing real-time changes in consumer behavior.

Recent comments from Fed officials, including Governor Waller, suggest that the upcoming PCE report will play a significant role in determining the trajectory of future rate cuts. Waller has indicated that the core PCE for August is expected to be very low, which could reinforce the case for maintaining or even accelerating the pace of rate cuts. However, other officials have expressed concerns that inflation is not yet fully under control, and there is a risk that aggressive rate cuts could revive inflationary pressures.

The PCE report will also provide insights into personal income and spending, which are expected to show moderate growth. Personal income is projected to increase by 0.4%, up from 0.3% in July, while personal spending is expected to ease to 0.3% from 0.5%. These figures will help gauge the strength of consumer demand and its potential impact on inflation moving forward.

Given the recent sharp decline in inflation from the 40-year highs seen in 2022, the Federal Reserve's decision to implement a 50-basis point rate cut last week was seen as a "recalibration" to maintain economic momentum. This report will be crucial in determining whether the Fed continues with its current pace of rate cuts or whether it needs to adjust its strategy in response to evolving inflation trends.

Investors are also likely to focus on how the PCE data will impact market expectations for future rate cuts. According to CME's FedWatch, there is currently a 60.2% expectation for a 50-basis point cut in November, compared to a 39.8% chance for a 25-basis point cut. The PCE report could either reinforce or shift these expectations, depending on how the data compares to the Fed's target.

Overall, the upcoming PCE report is expected to provide critical insights into the state of inflation and the potential direction of Federal Reserve policy. Investors and policymakers alike will be closely monitoring the results to gauge the health of the U.S. economy and the likely path of interest rates in the coming months.