The latest US PCE reading for August showed that US inflation is starting to move in the right direction again.
The index, closely watched by the Fed for use in their internal equations for calculating real inflation, rose to 1.8% in August.
This increase in the PCE deflator is the biggest gain on the year. And, although the month-on-month rise was a little weak at just 0.14%, it comes on the back of steady gains recently.
These have increased the shorter-term trends to 2.1% over six months and 2.5% over three months.
Core CPI Higher
Other inflation metrics are also pointing north.
The core CPI reading, which strips out food and energy prices, rose to 2.4% last month. This is well above the Fed’s 2% target.
Headline CPI is still running a little under at 1.7%. However, this figure would have been higher had it not been for volatility in gasoline prices. With the US jobless rate running at half-century lows and wage growth drifting higher, the backdrop for inflation is supportive.
Fed View Shifting
In light of better inflationary pressure, the Fed might soon start to shift its thinking away from obsessing over too-low inflation.
Last week we heard Fed Vice Chair Clarida downplaying inflation concerns saying that inflation expectations remain anchored to the target.
While he doesn’t expect inflation to pop higher in the near term, he didn’t support the need for further rate cuts in order to boost inflation.
This means that the Fed’s rate path adjustments will be linked to incoming data and ongoing US-China trade talks.
Rate Cut Expectations Lower
At its last meeting, the Fed was more heavily divided than before over the decision to cut rates.
With three-voting members voting against a rate cut, the market has subsequently had to rethink the pricing for further rate cuts this year.
Pricing for an October rate cut has now fallen even though, for now, one further rate cut is foreseen by year-end.
Trade Talks On Watch
The key to determining the likelihood of another rate cut will be monitoring the next round of US-China trade talks.
Officials from both countries are due to meet in Washington on October 10th.
The market appears quietly hopeful that we will see some signs of progress. Over recent weeks, reports have indicated the potential for an “interim” trade deal. This could pave the way for a fuller trade deal down the line.
Indeed, Trump himself told reporters recently that a trade deal with China could come a lot sooner than the market is expecting.
If we do see some signs of resolution from this next round fo trade talks, this would likely further pull down pricing for another US rate cut this year.
However, if talks fail to deliver any tangible results, this could hit economic activity. It could also support the need for the Fed to cut rates again.
The H4 view of USD shows the index having broken above the bearish trend line from year to date highs. 98.70 is acting as support for now.
Price has now broken above 99.10. This puts focus on a move higher to test the year to date highs around 99.33. If we retreat back under 98.70, the next key support levels to watch will be the 98.29 interim level ahead of major structural support at 97.57 (with the rising trend line from August lows just ahead).