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Markets Brace for U.S. PCE Inflation Data as Fed Considers September Rate Cut

As markets prepare to close a highly turbulent month, all eyes are on the critical inflation data from the U.S. The Personal Consumption Expenditures (PCE) price index, the Federal Reserve's (Fed) preferred inflation gauge, will be reviewed one last time before the bank's September monetary policy meeting.


Following Chair Jerome Powell's speech at Jackson Hole last week, a rate cut in September has become almost certain, but there is still speculation about the extent of the cuts. Market participants are pricing in a 25 basis point cut with a 65.5% probability, while a 50 basis point cut remains on the table with a 34.5% chance.


The key takeaway from last week's speeches by Fed officials was that the focus had shifted more towards labour market risks rather than inflation risks, with a preference to see more data before deciding whether a 25 or 50 basis point cut would be appropriate next month.


Ahead of the September 17-18 policy meeting, the Fed has two inflation reports (Aug 30 PCE and Sep 11 CPI) and one labor market report (Sep 6 NFP) to review. While the PCE data, as the Fed's preferred measure, will be prominent in the inflation context, whether the Fed considers a more aggressive 50 basis point cut will likely depend more on whether next week's data shows a deterioration in labor market conditions. For the PCE data to increase the likelihood of a 50 basis point cut or reverse expectations of a rate cut, it would need to deviate significantly from the forecasts.



Core PCE Expected to Edge Modestly Higher in July as Markets Eye Fed's Next Move


The June core PCE data remained steady at 2.6% year-on-year, unchanged from the previous month, while the headline PCE figure declined to 2.5%.


Meanwhile, the June policy meeting projections showed that the Fed had raised its 2024 headline PCE forecast to 2.6% and its core PCE forecast to 2.8%. Despite the Fed’s upward revision, the June PCE data, which revealed continued easing in price pressures, supported expectations for a rate cut in September.



On the other hand, markets are anticipating a 0.1 percentage point increase in the July PCE data compared to June. The headline PCE is expected to rise from 2.5% to 2.6% year-on-year, with a monthly increase of 0.2%. For core PCE, the monthly rate is projected to remain steady at 0.2%, while the annual rate is expected to increase from 2.6% to 2.7%.



However, even if the data meets expectations, this may not necessarily reignite inflation concerns in the U.S. or undermine the Fed's intent to begin a rate-cutting cycle.


As long as the PCE price index data does not exceed the Fed's year-end forecasts, it is unlikely to reverse the scenario of a possible rate cut at the September meeting. Conversely, if the data falls significantly short of expectations, it could increase bets on a 50 basis point cut in September.


Consequently, today's inflation data is expected to support the Fed's intent to begin a rate-cutting cycle. However, outside of these two extreme scenarios, markets seem likely to continue waiting for next week's payroll report to shape their expectations regarding the extent of rate cuts.

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