Latest Inflation Data Could Strengthen Argument for Additional Fed Rate Cuts, According to Reuters

By Howard Schneider

WASHINGTON (Reuters) – The moderation of inflation in August reinforced the rationale that Federal Reserve officials cited in support of their decision to reduce interest rates by half a percentage point last week. This development led traders to speculate that the U.S. central bank may sustain a rapid pace of rate cuts as inflationary pressures inch closer to the 2% target.

Recent data from the Commerce Department revealed that the personal consumption expenditures price index, excluding volatile food and energy prices, has been rising at an annual rate of under 1.8% over the past four months. During comments made last week, Fed Governor Chris Waller had anticipated this trend and expressed concern that inflation could be easing too quickly.

Waller remarked on CNBC, "I expected a monthly core PCE increase of 0.14%, which would push the three- and four-month rates down, and it caused me to rethink; inflation is softening much faster than I anticipated." The actual monthly figure for August came in at 0.13%.

Additional August PCE data corroborated various arguments that Fed officials presented following last week’s meeting. For instance, aspects of the housing market are now rising at an annual rate of less than 5% for the first time since early 2022.

Atlanta Fed President Raphael Bostic has highlighted the proportion of goods experiencing annual price increases of 5% or more as a notable indicator in his analysis of inflation. He pointed out that housing remains one of the last significant areas of persistent price pressure.

"The breadth of price increases is narrowing to a range consistent with price stability," Bostic stated following the Fed’s recent meeting. In July, only 18% of items showed price increases of 5% or more, marking the lowest percentage since 2020 and aligning closely with the long-term average of 17%. August calculations are yet to be released.

Bostic mentioned that housing is now one of the few remaining sectors showing elevated price pressures.

"If the Fed aims to cut by another 50 basis points in November, the inflation data won’t obstruct that decision," commented Omair Sharif, president of Inflation Insights. "The quicker inflation cools, the more motivation there is for a faster pace of rate cuts."

The Fed’s next policy meeting is scheduled for November 6-7. Current expectations among traders indicate that the central bank’s benchmark overnight interest rate will drop by three-quarters of a percentage point by the end of this year, suggesting another half-percentage-point cut could take place at that meeting or in December.

NOT QUITE A CONSENSUS

The decision to cut rates last week was not unanimously supported among Federal Reserve members. The central bank reduced the policy rate to a range of 4.75%-5.00%, following a period of 14 months during which rates remained steady while inflation declined.

Fed Governor Michelle Bowman dissented, advocating for a smaller quarter-percentage-point reduction, indicating that not all policymakers were fully on board with the decision to initiate the easing cycle with such an aggressive move.

For Bowman, the core PCE inflation rate’s uptick to 2.7% in August from 2.6% in July was not encouraging enough to warrant another substantial reduction. She expressed her dissent, stating that year-over-year core inflation remains "uncomfortably above our 2% target."

LABOR MARKET IS ‘JOB ONE’

Some policymakers emphasize that the year-over-year figures may decline significantly in early 2025 due to the calculated comparison against prior periods of rapid inflation, a phenomenon known as "base effects" that would favor lower year-over-year readings.

Consequently, certain officials now focus on more recent price data and the state of the job market, given their increased confidence in a return to the 2% inflation target. Fed Chair Jerome Powell has voiced concerns over the rising risks to the labor market.

The upcoming labor market reports, including the September jobs report due on October 4, may influence the Fed’s decision-making regarding the magnitude or speed of future rate cuts.

"There are numerous indicators pertaining to employment, and they collectively suggest that the labor market remains robust," Powell noted at his post-meeting press conference on September 18, highlighting the current unemployment rate of 4.2%, which is below the long-term average.

However, Powell acknowledged that several labor market indicators require close observation, remarking that "a broad set suggests that labor market conditions are now less tight than they were just before the pandemic," a time period he viewed as optimal in terms of low unemployment and sustainable wage growth without inflationary pressures.

The unemployment rate, for example, has been climbing, and officials project it to reach 4.4% by the end of 2024—significantly higher than the lows recorded in 2023 and above the level Powell inherited when he became Fed Chair in early 2018.

Moreover, Powell noted that the relationship between job openings and unemployment has shown signs of loosening, indicating that further reduction in job openings could lead more directly to higher unemployment rates.