November rate cut finely balanced after Fed's preferred inflation gauge remains sticky

Headline PCE inflation has cooled to 2.2%, near the Fed's 2% target, but the rise in core PCE to 2.7% shows inflationary pressures persist, especially in housing and services. This leaves the Fed balancing the risk of over-tightening and causing a recession against cutting rates too soon and reigniting inflation. Despite headline numbers suggesting a resilient economy, deeper issues persist. Consumer spending, which drives two-thirds of US GDP, is increasingly propped up by unsustainable debt levels. Credit card debt has reached a record $1.14trn, and delinquencies are on the rise. Job creation is slowing, and many Americans are working multiple jobs to stay afloat. This suggests that beneath the surface, the US economy is not as robust as it might appear, and the so-called strength could be masking growing financial stress for many households. Given this backdrop, the case for interest rate cuts may stem more from fears of a slowing economy rather than a victory over inflation.

The inflation dragon is losing its fire, as August's PCE data reveals a cooling trend and has reinforced market expectations for further rate cuts by the Fed. In the varied fabric of economic indicators, PCE inflation data is the golden thread that weaves through the Fed's ever-evolving decision-making process. As the favoured inflation gauge, these figures are pivotal in shaping upcoming policy decisions and act as a barometer for their monetary outlook. The combination of cooling inflation and moderating consumer activity will likely bolster the Fed's confidence in its recent pivot towards monetary easing. However, while the data is encouraging, the Fed’s dual mandate of price stability and maximum employment means that labour market indicators will also play a crucial role in shaping policy decisions. Additionally, with gold prices achieving continued record highs, this PCE reading might allow the precious metal to shine even brighter as the Fed is likely to remain firmly dovish.

While markets are pricing in a 50bps cut at the November meeting, a deeper dive into the latest PCE data reveals a more nuanced picture. The fall in headline PCE is masking underlying inflationary pressures that remain stubborn, as the huge drop was driven by declining energy costs and goods deflation. However, stickier elements of inflation remain stubbornly high, as year-over-year core PCE rose for the first since January 2023.

The labour market isn't showing tremendous signs of cooling either. Although personal income did fall, this was down to lower asset receipts and dividends, because wages actually rose from July.

Meanwhile, consumer spending, while down, was primarily due to decreased motor vehicle purchases, with services spending remaining robust. What's more, election jitters may be tempering some consumer spending, but overall strength persists. As such, looking beyond headline figures, there's little justification for the Fed to rush into another 50bps cut.

Jobs not jumps. US inflation is trending in the right direction, albeit with a tiny tick up in core PCE. JayPo seemed to be clear last time out that whilst inflation moves in their prefered direction, he remains laser focused on the jobs market and any signs of breakage there indicating potenially recessionary signals. Therefore, even if jobs numbers remain strong, the Fed will likely still proceed with rate cuts, even as the election approaches in November.