August PCE Lower than Expected

MACRO FRAME

US economic data this week (PMI, payrolls), paired with a host of Fed speakers is likely to significantly shape the near-term outlook for the Fed.

STOCK INDEX FUTURES

Equity index futures moved modestly higher following August’s PCE print, which came in lower-than-expected and pushed back expectations of an October rate hike. Q2 real GDP was revised up to 2.2% annualized, while real final sales to private domestic purchasers accelerated to 4.6%, underscoring strong underlying consumption and private fixed-investment demand. The Q2 inflation revisions were favorable at the margin, with core PCE revised down to 3.3% annualized. August data then showed consumer spending reaccelerating: nominal spending rose 0.9% m/m, even as real disposable income was flat and the saving rate fell to 4.1%. August core PCE inflation increased 0.2% m/m and 3.0% y/y, below market forecasts and a relatively contained monthly result but still above the Fed’s inflation objective. Overall, the releases support a resilient-growth, incomplete-disinflation narrative rather than a material near-term slowdown in inflation. Markets are now assigning a 37% probability of an October hike, a strong drop from yesterday’s pricing of 70% and are priced for 42 bps of tightening by January. The downwards repricing reflects the impact of today’s report, though Friday’s labor report presents another test. Strong labor growth could see rate hike expectations climb, but likely not enough to recover yesterday’s pricing.

Watch point: Despite tech volatility, the earnings backdrop suggests bullishness, despite the advent of a new hiking cycle.

CURRENCIES

US DOLLAR: The USD index fell 0.28% to 101.10 following the release of August PCE numbers, which led markets to significantly pull back expectations of an October rate hike. Looking ahead, September payrolls, ISM manufacturing PMI, and several Fed speakers will continue to shape market expectations of an October hike and consequently the dollar’s direction, though would likely require very strong readings to recover the same pricing odds the market held before today’s release. That leaves September’s PCE reading next month as the next big inflation release for the Fed, which gives markets and Fed members plenty of time to digest ongoing geopolitical dynamics and assess other economic data.

Watch point: A reduction in tightening expectations for the Fed will act as the greatest risk to the dollar maintain its move above the 100 level.

EURO: The euro rose 0.24% to $1.1366 in the wake of US data. Inflation in Germany, France, and Italy rose sharply, overnight data showed. Prices rose 3.3% y/y in Germany, France’s rate was 3.4%, up from 2.6% in August, and Italy recorded a jump to 4.1% from 3.2% in August. Despite the data, market expectations of an October rate hike from the European Central Bank are practically unchanged, priced at 39%. The lack of conviction in the markets for an October rate hike is likely attributed to comments from several European Central Bank officials; ECB policymaker Kazimir today said the bank has time to be flexible, striking a similar tone to President Lagarde, who spoke on Monday.

Watch point: Broader price direction will be subject to Fed-ECB policy expectations, which has been favorable to the dollar in advent of a hawkish repricing in Fed policy expectations the near-term.

BRITISH POUND: Sterling rose 0.45% to $1.3288 to its highest level following weaker-than-expected PCE data and revised Q2 GDP data, which revealed the economy faster than previously expected in the second quarter. GDP rose 0.5%, a modestly higher than the initial estimate of 0.4%. Still, despite the growth, money market remain overly hawkish in our opinion. Money markets are priced for nearly four rate hikes over the next 10 months from the BoE, and see an 82% chance of a move in November. However, that pricing appears at odds with current economic conditions in the country, which will limit the central bank from tightening rates as aggressively as markets expect.

JAPANESE YEN: The yen gained 0.3% to 156.81 yen per dollar. The yen is still finding support from currency diplomat Atsushi Mimura’s comments on Monday, who said that markets should take at face value the “very clear” message Tokyo and Washington delivered last week on the yen. Last week, Finance Minister Katayama and Treasury Secretary Bessent reaffirmed their cooperation to combat yen weakness. Focus is also on The Bank of Japan’s Tankan corporate sentiment survey on Thursday, which will be followed by the BOJ’s summary of opinions from its September meeting, where it raised its policy rate to 1.25%. Sentiment regarding the currency has been damaged after the BOJ underwhelmed the investors following its divided decision to raise rates and Governor Ueda’s unconvincing press conference at the meeting. The greatest near-term upside risk for the currency remains market intervention. Markets are pricing roughly a 30% chance of a hike in October and see 21 bps of tightening by year-end.

Watch point: While markets are underwhelmed at the BOJ, a path for additional rate hikes looks to be the primary scenario.

AUSTRALIAN DOLLAR: The Aussie is 0.21% lower at $0.6969 despite the dollar losing ground against most currencies as inflation data came in just under forecasts and led markets to further reduce odds of a near-term rate hike. CPI rose 0.4% m/m in August, under forecasts got 0.5%. The trimmed mean measure of core inflation rose 0.2% in August, under forecasts of 0.3%, though the annual pace held at 3.6% for a third straight month. This follows the Reserve Bank of Australia’s decision to raise rates by 25 bps to 4.60%. The board unanimously voted to raise its cash rate, the fourth hike this year. RBA Governor Bullock said the board believed financial conditions were now tight but were unsure if that would be enough to bring inflation down. She also noted policy worked with a lag and the board wanted to see how the hikes already delivered would impact the economy, a signal markets took as a potential end to further tightening. Bullock referenced that inflation data will play the greatest role in determining where policy lands in the future.

Watch point: August’s hiring figures argue for a higher-for-longer stance, leading the focus to Q3’s inflation data.

TREASURY FUTURES

Yields moved lower across the curve, with the 10-year yield down 2.5 bps to 5.25%, following August’s PCE data, which came in modestly below expectations, providing some near-term relief to the Fed, but the underlying demand data retain a hawkish cast. The core PCE price index rose 0.2% m/m and 3.0% y/y, while headline PCE increased 0.3% m/m and 3.4% y/y. The softer core outcome should ease immediate concern that inflation is reaccelerating and gives policymakers room to await additional evidence. However, consumer spending remained notably firm, rising 0.9% m/m and real PCE gained 0.6%, following a weak July. With real disposable income flat and the saving rate falling to 4.1%, households supported spending at a pace that outstripped current income growth. The accompanying GDP revisions further strengthen the case for policy patience. Q2 real GDP was revised up to 2.2% annualized, while real final sales to private domestic purchasers were revised to a robust 4.6%. The latter measure, capturing consumer spending and private fixed investment, suggests underlying domestic demand was considerably stronger than the headline GDP figure alone implies. For yields, the release supports a modest near-term bull-steepening at the front end, but limits the case for a sustained rally across the curve. Elsewhere, NY Fed President Williams said there was “no need for urgency” in raising rates.

Watch point: Inflation risk, fiscal and corporate supply, capital competition and term premium will be key factors in determining whether the yield curve maintains its recent flattening or falls into a bear steeping move.

Interested in more futures markets?  Explore our Market Dashboards here.