Inflation Decline Strengthens Confidence In Fed's Interest Rate Cut: 'If You Were Second Guessing The Fed... You Aren't Now'

Friday's Personal Consumption Expenditures (PCE) Price Index report showed lower inflation in August than expected, which has economists cheering the results and their positive impact for consumers and the stock market.

What Happened: The Personal Consumption Expenditures Price Index is the preferred inflation gauge used by the Federal Reserve and may help determine if and when additional rate cuts will happen.

The PCE increased 2.2% year-over-year in August. The figure came in below the 2.3% estimate from analysts and below the 2.5% year-over-year increase reported in July.

Core PCE, which excludes food and energy from the data, was up 2.7% year-over-year in August, which was in line with estimates from analysts and 0.1% above the July figure.

Disposable personal income was up $34.2 billion (0.2%) and personal consumption expenditures were up $47.2 billion (0.2%) in August, according to the report.

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Economists Reactions: Friday's preferred inflation metric showed the lowest reading since 2021, RSM US LLP Chief Economist Joseph Brusuelas tweeted after the report.

"Lower inflation and the Fed's easing cycle will bring down the weighted average cost of capital going forward as the central bank reduces the policy rate to 3% over the next year," Brusuelas said.

The economist said the lower weight average cost of capital will result in "rising private sector investment" in items that support productivity improvements. The investments could support hiring at higher salary levels ($100k to $150k) that will help provide "stable employment conditions," the economist added.

"The significant upward revisions to GDP/GDI along with the disinflation that one can observe in the data are the signals amidst the noise induced by pandemic era residual seasonality and the election."

Brusuelas said the 2.2% figure nearly hits the Fed's 2% target and opens the door for a "less restrictive policy stance." The data also supports a 50-basis point rate cut in November, the economist said.

"This is what an economic expansion looks like at full employment."

PCE inflation data coming in at or below expectations should be "marginally good for markets," Independent Advisor Alliance Chief Investment Officer Chris Zaccarelli said.

"The more important fact is that it is lower than the prior month showing that inflation is receding," Zaccarelli said.  

Zaccarelli said with inflation under control and trending in the right direction, the Fed can now focus more on the labor market.

"As the Fed cuts rates – especially in the absence of recessionary growth – it is a great tailwind for both stock and bond markets and should eventually provide some relief for those consumers that are more interest-rate sensitive."

Friday's PCE report supports the Fed's decision to "go big" with a 50-basis point rate cut in September, LPL Financial Chief Global Strategist Quincy Krosby said.

"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," Korsby said.

With inflation near the 2% goal, the Fed can get closer to declaring victory on inflation, but it is not there yet, Krosby added.

Harris Financial Group Managing Partner Jamie Cox said Friday's PCE data shows the Federal Reserve may have been right about their rate cut decision earlier this month.

"If you were second guessing the Fed going .50 in September, you aren't now," Cox said.

Cox said a 50-basis point rate cut in November is likely.

"Inflation is no longer the story in the PCE data for the Fed. It's now all about spending and keeping the economy strong."

SPY Price Action: The SPDR S&P 500 ETF Trust SPY is up 0.11% Friday to $572.92 on the heels of the PCE report. The ETF hit new 52-week highs earlier in the week and has a 52-week trading range of $409.22 to $574.71, as seen on the Benzinga Pro chart below.

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