US inflation cooled slightly in August, with the Federal Reserve’s preferred measure of price pressures coming in below economists’ expectations, prompting markets to reassess the likelihood of a near-term interest rate hike.
Core inflation slows to 3.0% as August PCE data misses forecasts
The personal consumption expenditures (PCE) price index, the Fed’s primary inflation gauge, rose 3.4% year-over-year in August, down from the 3.7% forecast and matching the revised July reading. On a monthly basis, PCE inflation increased 0.3%, below the 0.4% expectation. Excluding volatile food and energy prices, core PCE inflation—widely considered a better indicator of underlying trends—rose 3.0% annually, also below the 3.3% forecast, and 0.2% monthly, slightly under the 0.3% expectation. The data reflects annual adjustments to the index’s methodology, including revisions to price calculations for software, investment advice, and legal services.
Markets react as Fed rate hike odds decline
Following the release, stocks on Wall Street and Treasury prices rose, while the 2-year US bond yield fell, signaling reduced expectations for a Fed rate hike next month. Market pricing indicated a 65% chance the Fed would hold rates steady in October, up from 55% before the data. The 10-year US Treasury yield, however, remained elevated for the month, reflecting broader concerns over government debt and energy-driven inflation tied to geopolitical tensions. Oil prices also climbed, contributing to the commodity’s monthly gains.
Economic growth revised upward as inflation cools
Separate data released Wednesday showed the US economy grew at a faster-than-expected annualized rate of 2.2% in the second quarter, revised up from the prior estimate of 1.5%. While inflation remains above the Fed’s 2% target, the softer-than-anticipated PCE figures suggest price pressures may be easing, though policymakers have emphasized the need for sustained progress before declaring victory.
Energy and services drive monthly inflation
The August inflation increase was primarily driven by a 2.3% rise in energy prices, including a 4.4% jump in gasoline costs, and a 1.4% increase in transportation services. Goods prices rose 0.3% month-over-month, while services also climbed 0.3%, contributing to the overall uptick. The Bureau of Economic Analysis noted that methodological changes, including retroactive adjustments to earlier data, influenced the final figures, though the full impact of these revisions was not immediately clear.
Fed’s dual mandate under scrutiny
The Fed has raised interest rates twice this year—most recently in September—to combat inflation, but the latest data complicates the path forward. While headline inflation has softened, monthly core inflation remains sticky, and officials continue to weigh the risks of overtightening against the need to ensure price stability. Some analysts argue the Fed may pause further hikes if inflation continues to trend downward, while others caution that elevated services inflation could keep pressure on policymakers to act.
Global markets reflect mixed signals
Despite the US market’s positive reaction, global stocks tracked by MSCI’s gauge fell 0.8% for the month, with Wednesday’s gains not enough to offset broader declines. The divergence highlights ongoing concerns about growth outside the US, particularly amid rising energy costs and geopolitical risks, including the seven-month-old US-Israeli conflict with Iran, which has kept energy markets volatile.
What’s next for the Fed?
The Fed’s next policy meeting is scheduled for October 31–November 1, with markets now pricing in a higher probability of a rate hold rather than another hike. Investors and economists will closely monitor upcoming labor market and inflation reports to gauge whether the recent cooling trend persists or proves temporary. The Fed has emphasized a data-dependent approach, leaving room for flexibility but also underscoring the uncertainty of the current economic environment.