The Fed’s preferred inflation gauge gives green light for September rate cut

The Fed's favorite inflation measure has dropped to a three-year low, offering further evidence that America’s battle against inflation is turning a corner.

According to the Department of Commerce, the core Personal Consumption Expenditures (PCE) index increased by 0.2% in June and 2.6% annually.

The annual growth of core PCE hasn't budged since May, matching the lowest reading in more than three years.

Goods prices declined by 0.2% after falling 0.4% the previous month. The prices of furnishings, durable goods, motor vehicles and parts were all down compared to the previous month.

Inflation is cooling at a time when Americans are tightening their belts. The same Commerce Department report found that inflation-adjusted expenditures rose just 0.2% in May.

While this isn’t an immediate concern, economists say a slowdown in consumer spending could be a harbinger of deeper problems in the economy.

The latest data “indicate U.S. consumers are getting stretched thin,” wrote Bloomberg economists Stuart Paul, Estelle Ou, and Eliza Winger. “And with the labor market cooling, we think consumption growth will ease further in the second half of the year.”

Since reaching a low of 3.4% in 2023, the U.S. unemployment rate has inched back up to 4.1%. The pace of hiring has also cooled, job hopping isn’t nearly as common as it was during the pandemic, and wage increases have slowed.

The end result is a more weary consumer that’s becoming a drag on economic growth. That’s why economists believe the Fed should step in before things get worse.

Enough progress for a September rate cut?

According to Goldman Sachs, a recent uptick in unemployment is a canary in the coal mine, indicating a slowing economy.

Goldman analysts cited three areas of labor market weakness that should alarm policymakers: slowing household income growth, declining hiring rates, and rising unemployment.

But it's not just labor woes that are giving the Fed a reprieve. Experts say that recent progress on inflation should give policymakers enough conviction to cut rates.

“From the Fed’s perspective, cumulatively, we think the data show enough progress—on both inflation and labor market conditions—for policymakers to open the door to a rate cut in September,” said Rubeela Farooqi, chief U.S. economist at High Frequency Economics.

According to Olu Sonola, who heads U.S. economic research at Fitch Ratings, “The Fed is now likely to use the meeting next week to set the stage for a September rate cut.”

If Sonola is correct, the Fed’s July 30-31 meeting will provide markets with much-needed guidance on when to expect rate cuts. It could also provide clues about how many rate reductions are expected this year.

Investors widely expect the central bank to begin lowering rates in September. Based on the latest Fed Fund futures prices, the likelihood of a September rate cut is close to 100%.