Markets have been in a bit of a holding pattern ahead of Friday’s US July PCE price index data. That’s because it’s the Fed’s preferred inflation indicator, which could help clarify some of the conflicting data that has emerged recently. Earlier in the month, a discrepancy emerged between CPI figures and PPI data, with a focus on the impact of tariffs. Markets may view the PCE figure as definitive, at least in terms of its effect on the monetary policy outlook.
Following the Fed’s more dovish stance at the Jackson Hole Symposium, expectations are likely to be that the upcoming data will reinforce the odds of a rate cut in September. Future markets were predicting a 70% chance of a rate cut, but that rose to 90% after Fed Chair Powell’s speech on Friday. One of the factors in focus is whether to expect further rate cuts after September as well.
Pricing in the Second Cut
Given how strong the consensus has become for a September cut, what could have a bigger impact on the market is what comes after. Most major banks predict two rate cuts for the rest of the year: One in September and the second in December. That aligns with the latest Fed “dot-plot” matrix, which showed a consensus among the FOMC for two rate cuts in the second half of the year.
However, to achieve those cuts, inflation would have to at least not rise much further. The PCE price index rose through the summer, as the effects of tariffs were finally seen filtering through to the economy. How much of an impact, and for how long, is part of the internal debate at the Fed. This month, both factions got data to support their position, which left markets cautiously optimistic about a rate cut.
What to Look Out For
The Fed’s preferred measure of inflation is the core PCE price index. The July reading is projected to stay unchanged at 2.8%, which is well above the Fed’s 2.0% target. But what could matter more this time is the components and direction of the data, instead of the headline number.
Traders will likely closely monitor price changes in sectors affected by tariffs and compare them to those in other industries. For example, automotive compared to energy. This could provide important insight into whether there is a growing influence from increased import taxes. In that case, the markets might be worried that the Fed will be hesitant to cut rates. But if tariff-driven inflation isn’t as much as expected, then the market could regain confidence in further rate cuts.
Potential Market Reaction
The market may have an unusual reaction to the data this time, as traders will likely factor in the economic impact as well. Generally, inflation above target means the central bank will keep interest rates elevated, which supports the currency. But with higher Fed rates weighing on the US economy, the dollar might not gain support if inflation his higher than expected, particularly if inflation rises due to tariffs, as that would likely imply a slowdown in the US economy.
On the other hand, gold could receive support if inflation comes in below expectations. That’s because usually lower rates support the yellow metal. However, if inflation is higher than expected, investors may also find gold appealing as a store of value.