The Federal Reserve’s key inflation measure showed consumer prices rose at a slower-than-expected year-on-year rate in August, the U.S. Commerce Department said Wednesday.
The personal consumption expenditure price index rose a seasonally adjusted 0.3% in the month, bringing the 12-month rate of increase to 3.4%. Economists surveyed by Dow Jones had expected increases of 0.3% and 3.7%, respectively.
Excluding food and energy, PCE rose 0.2% to a core level of 3% for the year. Expectations were 0.3% and 3.3%, respectively.
Although the Fed officially follows the headline PCE number, officials generally believe that the core is a better measure of long-term trends.
The annual increase was smaller than expected, but the increase was due to changes in the way the Bureau of Economic Analysis calculates some components of the index. BEA has adjusted the way it measures prices for legal services, software, computer accessories, and portfolio management.
As a result of this revision, the core PCE level for July was lowered by 0.36 percentage points.
Stock market futures rose on the report, but U.S. Treasury yields turned negative. Traders were pricing in the possibility that the Fed would raise rates in October, with expectations for the next rate hike pushed back to December.
“This is good news for investors concerned about the recent spike in bond yields and confirms the rationale for holding off on raising rates in October,” said David Russell, global head of market strategy at TradeStation. “However, the data is also relatively old at this point and does not reflect this month’s rise in diesel prices.”
The report also showed that personal income increased by 0.2% and spending increased by 0.9%, compared to the consensus of 0.4% and 0.8%.
Inflation remains high and GDP has been revised upwards
Both PCE levels remain well above the central bank’s 2% target, raising the possibility that the Fed will follow up its September rate hike with another rate hike at any of its remaining meetings this year (in October or, more likely, in December).
“Even after a major methodology overhaul, PCE inflation is still trending upward no matter how much we reduce it,” said Sonu Varghese, global macro strategist at Carson Group. “The economy is hot, policy remains accommodative, and the Fed’s challenge is to determine how much restraint is needed. This is a tailwind for stocks heading into the fourth quarter.”
Although energy costs were the main driver of price increases in August, several other sectors also showed increases. Gasoline prices rose 4.4% and transportation services rose 1.4%. Energy products and services rose 2.3%.
Prices of goods and services both rose by 0.3%.
“The Fed’s favorite PCE inflation numbers do not show progress on inflation in August,” said Heather Long, chief economist at Navy Federal Credit Union. “And it’s inevitable that September will be even higher. Meanwhile, U.S. consumers are feeling the squeeze.”
In other economic news Wednesday, the Commerce Department reported that gross domestic product grew at an annualized rate of 2.2% in the second quarter, according to the final of three estimates. This was a significant increase from the previous estimate of 1.5%, reflecting the large contribution not only from investment but also from consumer and government spending.
Real final sales to domestic private buyers, a measure closely watched by Fed officials to gauge the economy’s underlying demand, rose 4.6%, revised upward by 0.4 percentage point.
Inflation indicators for the April-June period also fell slightly, with the overall PCE price rising 5% and the core price rising 3.3%, each 0.3 percentage points lower than advance expectations.
Mixed economic signals are troubling for the Fed.
Policymakers can usually identify price increases caused by exogenous factors, such as tariffs or supply shocks from war with Iran. However, unknown factors such as continued price increases and advances in artificial intelligence are challenging traditional thinking.
Markets had strongly priced in the possibility that the Fed would raise interest rates by a quarter of a percentage point in September and then again in October. But comments Tuesday from influential New York Fed President John Williams tempered those expectations, and Wednesday’s data further dimmed the outlook for October.
“With the policy actions we took at our September meeting, there is no need to rush. We have time to gather more information,” Williams said in his speech, a comment that caused an almost immediate adjustment in expectations.
Williams added that he still thinks “an additional rate hike later this year may be appropriate,” with the market pricing in the next rate hike by December.
