Tariff Pressures and Hotter PCE Trim Odds of September Fed Cut, Markets Still Cheer Strong Economy

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The Federal Reserve’s decision to hold interest rates steady this week was quickly tested by fresh economic data showing inflation running slightly hotter than expected. The June Personal Consumption Expenditures (PCE) report, released Thursday, suggests the hurdle for a September rate cut has grown taller, and futures markets are adjusting accordingly. While Wall Street is cheering blockbuster earnings from Microsoft and Meta, the macro backdrop is quietly shifting in ways that could temper hopes for near-term easing.

The core PCE price index—the Fed’s preferred inflation gauge—rose 0.3% month-over-month in June, with the year-over-year rate ticking up to 2.8%, just above the 2.7% forecast economists had penciled in. Headline PCE rose 2.6% year-over-year, also edging past expectations of 2.5%. While the uptick looks modest, it carries weight given Chair Jerome Powell’s comments Wednesday that the Fed’s baseline view was for inflation to stay roughly in line with forecasts. The fact that prices overshot that baseline, however slightly, will likely reinforce the central bank’s caution.

Digging into the report, much of the pressure came from tariff-sensitive goods. Gasoline and other energy goods jumped $11.5 billion, reflecting higher import costs and sanctions-related supply concerns. Food and beverages rose $6.8 billion, with agricultural tariffs and transportation costs contributing to the climb. Other nondurable goods added $7.9 billion, a broad category that captures staples increasingly exposed to trade-policy pass-through. Clothing and footwear rose $4.2 billion, highlighting the cost drag from textile tariffs, while furnishings and household equipment gained $2.9 billion despite facing headwinds from imported durable goods.

Notably, motor vehicles and parts were a major drag, down $6.1 billion—the steepest category decline. Analysts cite tariff-related cost pressures and higher financing rates as key factors weighing on auto demand. Services carried the spending growth, led by healthcare (+$17.5 billion) and housing and utilities (+$16.3 billion). Still, even here, signs of consumer trade-offs emerged, with recreation services down $4.9 billion and transportation services off $2.8 billion.

The labor market data released alongside the PCE report painted a mixed picture. Initial jobless claims for the week ending July 26 came in at 218,000, up just 1,000 from the prior week and better than the 225,000 expected. The four-week moving average dipped to 221,000 from 224,500, underscoring that despite headline layoff announcements, claims remain historically low. Continuing claims held steady at 1.946 million. Still, the Challenger, Gray & Christmas report showed U.S. employers announced 62,075 job cuts in July, up 29% from June and a striking 140% higher than a year ago. Year-to-date, announced cuts total over 806,000, with government-led reductions playing a significant role. That disconnect—low claims but high announced cuts—will be closely watched for signs of stress in the labor pipeline.

The Employment Cost Index (ECI) added to the inflationary picture. Wages and salaries rose 1% in Q2, while benefits increased 0.7%, driving an overall increase of 0.9%. That topped economist expectations of 0.8% and matched the Q1 pace. While not alarming in isolation, the ECI’s persistence above forecasts reinforces the Fed’s concern about sticky wage inflation.

Taken together, the data complicates the Fed’s calculus. Ahead of this week’s decision, markets priced in better than 60% odds of a September cut. Following Powell’s press conference and Thursday’s releases, that probability has fallen to about 40%. Odds of no cut at all in 2025 have climbed to 15% from nearly zero a month ago, while the case for just one cut this year looks increasingly fragile. The implied path now reflects a Fed content to sit tight unless inflation moderates more clearly or labor market weakness emerges.

This repricing isn’t being received as bad news, however. Equity markets have rallied sharply, with S&P 500 futures pointing to new record highs on the back of Microsoft and Meta earnings. For investors, the message is that the economy remains in good shape: consumers are still spending, wages are rising, and inflation, while firm, isn’t accelerating out of control. The concern is less about overheating and more about ensuring that tariffs and energy-related price shocks don’t reignite broader inflation pressures.

The bottom line is that the June PCE report and labor data have reduced the likelihood of a September rate cut, reinforcing the Fed’s cautious tone. Tariff-related price increases in goods categories are keeping inflation sticky, while the ECI suggests wage growth remains firm. Yet jobless claims data points to a still-resilient labor market, softening the case for urgent easing. For Powell and his colleagues, this means the Fed can afford to wait and see—an approach markets appear to be endorsing for now.