A fresh reading on inflation Friday keeps the Federal Reserve on track to continue cutting interest rates this fall, likely in 25 basis point increments.
The Fed’s preferred inflation gauge — the so-called core Personal Consumption Expenditures (PCE) index that excludes volatile food and energy prices — clocked in at 2.7% over the prior year during the month of August.
That was in line with expectations and up a tenth of a percent from 2.6% in July. It remains above the Fed’s 2% target.
The result means that a bigger 50 basis point cut may be hard to justify at the Fed’s next meeting in November, according to some Fed watchers.
The fact that core inflation year-over-year is holding the level of the last two months, and not dropping, lines up more with a scenario for a smaller cut — lest the job market substantially weaken between now and November.
“The core year-over-year at 2.7% suggests that another round of 50 basis points needs to come under careful scrutiny unless the labor market suggests weakness,” said Quincy Krosby, chief global strategist for LPL Financial.
Measured on a month over month basis, PCE looked even better. That measure rose just 0.1% compared with expectations for 0.2%, and down from 0.2% in July and June.
When food and gas prices are added back in, PCE rose 2.2% in August — just two-tenths away from the Fed’s 2% inflation target. That was lower than estimates of 2.3% and down from 2.5% in July.
“Fed officials are feeling pretty good about where inflation is sitting,” said Pimco managing director Tiffany Wilding, who is predicting two more 25 basis point cuts in November and December.
Investors, however, are still split on whether the Fed will cut from 25 basis points or 50 basis points at the next policy meeting in November. The odds of a bigger cut rose slightly to 54% following the release of the PCE data.
The consensus among Fed officials outlined last week is for two more 25 basis point rate cuts in 2024.
They made this prediction while approving a new 50 basis point cut, the first such reduction since 2020, as they cited confidence that inflation is on its way down and evidence that the job market is cooling.
Fed Chair Jerome Powell and other officials have made it clear the Fed has not declared victory over inflation yet.
“We’re close, but we’re not really at 2 percent and I think we’re going to want to see it be around 2 percent and close to 2 percent for some time…we’re not saying mission accomplished,” Powell said last week.
If inflation were to stall, that could cause officials to pause lowering rates.
Fed Governor Adriana Kugler said this week that if core PCE clocked in at 2.7% that would be “consistent with ongoing progress toward the FOMC’s 2% target,” implying that the current path for two more smaller 25 basis point rate cuts would be in line with the current rate cut path.
Atlanta Fed president Raphael Bostic also made it clear ’his concern about inflation not yet hitting the Fed’s 2% target is keeping him from cutting in larger increments
Fed Governor Michelle Bowman, who dissented at the last policy meeting because she would have preferred to cut by 25 basis points instead of 50 basis points, is still more concerned about inflation than her colleagues.
Bowman said she sees “greater risks to price stability, especially while the labor market continues to be near estimates of full employment.”
Core inflation, according to Bowman, is uncomfortably high and that the upside risks to inflation remain prominent given high government spending and the fact that global supply chains continue to be susceptible to labor strikes and geopolitics.
Minneapolis Fed president Neel Kashkari, on the other hand, said this week he doesn’t see much evidence inflation might surprise to the upside, pointing to wages and core non-housing services prices that continue to fall.
“Although the Fed cannot declare complete victory on inflation, today’s report – with 2.2% on the year-over- year headline – underscores that overall inflation continues to move decisively in the right direction,” said Krosby of LPL Financial.
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