The Fed’s Favorite Inflation Index Shows Signs of Cooling
In a promising development for the U.S. economy, inflation has slowed further, bringing it in close alignment with the Federal Reserve’s target of 2%. According to data released by the Commerce Department on Thursday, the Personal Consumption Expenditures (PCE) price index, the Fed’s preferred inflation measure, showed that prices rose by just 2.1% for the year ending in September—down from 2.3% in August. This marks the lowest annual increase in three and a half years, aligning perfectly with what economists had anticipated, according to FactSet consensus estimates.
Encouraging Signals for the Federal Reserve
This latest inflation reading reinforces the notion that the previously high price hikes are being tamed, which is likely to fuel expectations for the Federal Reserve to continue on its path of cutting interest rates. As Olu Sonola, head of U.S. economic research at Fitch Ratings, commented, “The die is more or less cast for a rate cut next week, and the totality of the incoming data we’ve seen thus far this week supports that decision.” He added, “The bottom line is that the labor market remains strong, inflation is broadly disinflationary with some bumps along the road, and economic growth is solid.”
On a monthly basis, the PCE index rose by 0.2%, largely driven by increasing food prices, even though falling gas prices helped to keep gains in check. Many states are currently experiencing gas prices below $3 a gallon, a trend that is predicted to continue as global supply outpaces demand.
Core PCE Index: A Look Beneath the Surface
For a clearer picture of underlying inflation trends, the core PCE price index—which excludes volatile food and gas prices—rose by 0.3% in September, maintaining an annual rate of 2.7% for the third consecutive month. Factors contributing to the persistent core PCE rate include sticky price pressures in real estate, housing, and insurance. Gregory Daco, chief economist at EY Parthenon, stated that “generally speaking, inflation is within striking distance of the Fed’s 2% target,” supporting the argument for the Fed to recalibrate its monetary policy that was enacted during the period when inflation hovered closer to 6%.
The Fed’s Possible Moves
The Federal Reserve commenced a shift in its approach during September, announcing a larger-than-expected half-point rate cut. However, minutes from the most recent meeting revealed that not all members were unanimously behind this substantial reduction. Nevertheless, projections and statements from Fed Chair Jerome Powell indicate that two additional smaller cuts may be on the horizon to close out the year. Market expectations overwhelmingly suggest that the Fed will implement a quarter-point cut during its upcoming meeting next week, according to the CME FedWatch Tool.
Current Economic Landscape
The PCE price index is part of the Commerce Department’s monthly Personal Income and Outlays report, which offers a detailed overview of how Americans earn, spend, and save. The latest report revealed that both income and spending rose for the month, increasing by 0.3% and 0.5%, respectively. When adjusted for inflation, spending rose by 0.4%. This uptick in consumer spending outpaced income gains, leading to a slight reduction in savings, which fell to 4.6%—the lowest rate recorded this year. However, upward revisions to the savings rate provide some comfort regarding the economic well-being of consumers, according to Gus Faucher, chief economist at PNC.
Looking Ahead: Job Growth and Economic Stability
Economists forecast that the U.S. economy added approximately 117,500 jobs in October, a significant drop from the gains reported in September. The upcoming jobs report is expected to reflect distortions caused by recent strikes and hurricanes, which could collectively impact payroll gains by as much as 100,000 jobs. Consensus estimates predict a net gain of 117,500 jobs, down from September’s impressive figure of 254,000. Despite these temporary disruptions, economists remain optimistic about overall job growth, citing the ongoing strength of the labor market.
“Spending growth was especially strong in September, and cannot continue to indefinitely outpace income growth,” Faucher noted. He emphasized that the sturdy labor market and good job and wage gains could sustain consumer spending, thereby driving overall economic growth.
As the Federal Reserve prepares for its pivotal meeting next week, the latest data presents a mixed but promising outlook. With inflation inching closer to target levels and the economy displaying resilience, the central bank may reconsider its current stance on interest rates, providing further support for consumers and the broader economy.
