All Eyes On PCE: What to Expect From Fed's Key Inflation Metric This Friday

The Bureau of Economic Analysis is set to release the Federal Reserve’s preferred measure of inflation, the personal consumption expenditure (PCE) index for August at 8:30 a.m. ET Friday.

Why the PCE Index Matters to the Fed

The PCE price index is the Fed’s preferred tool for tracking inflation, and it’s not without reason. Unlike other metrics, such as the consumer price index, the PCE index casts a wider net.

It encompasses a broader range of goods and services while dynamically adjusting its weightings to mirror consumer spending patterns. This dynamic approach provides a more accurate portrayal of underlying inflationary pressures.

August PCE Report: Market Expectations

Here’s what economists are forecasting:

• The headline PCE price index is expected to rise from July’s 3.3% year-on-year increase to a 3.5% year-on-year jump in August.
• On a monthly basis, the headline PCE price index is projected to show a 0.5% increase month-over-month, a notable uptick from July’s 0.2% rise. If these predictions hold true, it would mark the most significant monthly surge since January 2023.
• The core PCE price index (excluding energy and food) is forecasted to ease from 4.2% year-on-year to a 3.9% year-on-year increase in August.
• The monthly increase in the core PCE price index is expected to remain steady at 0.2%, mirroring the previous month’s pace.

Insights from August’s CPI Report

To get a sneak peek into what the PCE report might reveal, we can examine the August CPI report. In August, the annual headline CPI rate accelerated for the second consecutive month, rising from 3.2% in July to 3.7% in August. On a monthly basis, prices increased by 0.6%, aligning with expectations.

The surge in inflation was largely driven by soaring gasoline prices, which saw a 10.6% increase during the month, compared to a mere 0.2% rise in July. Core inflation, which excludes food and energy, slowed for the fifth consecutive month, registering at 4.3%, consistent with market expectations.

Read also: Inflation Spikes Beyond Forecasts To 3.7% In August, Forces Markets To Rethink Fed Policy

PCE Inflation: What The Fed Envisions Next

During the most recent Federal Reserve Open Market Committee meeting, the Fed shared its updated economic projections. In terms of the PCE price index:

• The Fed expects the headline index to close out 2023 at 3.3%, drop to 2.5% in 2024 and settle at 2.2% by the end of 2025. The Fed anticipate hitting its 2% inflation target by late 2026.
  
• For the Core PCE Price index, the Fed’s latest projections include 3.7% by year-end 2023, 2.6% for 2024, 2.3% in 2025 and 2% for 2026.

Market Sentiment And The Bigger Picture

Traders aren’t banking on further interest rate hikes by the Fed this year.

Market-implied rate hike probabilities, as measured by the CME Group’s Fedwatch Tool, paint a picture of an 80% likelihood the Fed will hold rates steady in November, with a 64% chance of the same scenario unfolding in December.

Despite this, the market’s first rate cut isn’t expected until July 2024, reflecting the Fed’s commitment to keeping interest rates elevated for an extended period.

The U.S. dollar, as tracked by the the Invesco DB USD Index Bullish Fund ETF UUP, is riding high at the highest in 10 months, and the yield on the U.S. 10-year Treasury note is hovering at a level we haven’t seen since July 2007.

With the stock market experiencing September jitters, the SPDR S&P 500 ETF Trust SPY is down nearly 5% this month.

Now read: US Government Shutdown Risks Data Blackout, Here Are 5 Key Alternatives For Investors

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