Fed's preferred inflation gauge cooler than expected, likely delaying rate hike to December

• Core PCE rose 3% annually versus expectations of 3.3%, with overall PCE at 3.4% versus estimated 3.7%; methodology changes for measuring legal services and software prices may have contributed to the lower reading
• Energy costs drove much of August's price increase, with gasoline jumping 4.4% due to Middle East supply disruptions keeping prices above $4 per gallon
• Markets responded positively with the S&P 500 up 0.7% and Nasdaq up 1.1%, while odds of an October rate hike dropped from 45% to 37% as traders now expect December action

Summary

The Federal Reserve's preferred inflation measure, the core PCE price index, rose 0.2% monthly and 3% annually in August, below expectations of 0.3% monthly and 3.3% yearly. Overall PCE increased 0.3% monthly and 3.4% annually, also below the forecasted 3.7% annual rate.

Key Market Impact:

The cooler-than-expected data reduced October rate hike odds to 37% from 45%, with markets now pricing in a more likely December increase. Traders believe the Fed may avoid appearing politicized by raising rates before November midterm elections.

Sector Highlights:

Energy costs drove price increases, with gasoline jumping 4.4% amid Middle East supply disruptions, keeping prices above $4 per gallon. Transportation services rose 1.4%, while overall energy goods and services climbed 2.3%.

Economic Context:

• Q2 GDP revised upward to 2.2% annualized growth from 1.5%, driven by consumer/government spending and business investment
• Private employment added 90,000 jobs in September (ADP report)
• Real final sales to private domestic purchasers jumped 4.6%, signaling strong underlying demand
• The Bureau of Economic Analysis adjusted methodology for measuring legal services, software, and portfolio management prices

Market Reaction:

Stocks rose modestly: Dow up 0.2% (~95 points), S&P 500 +0.7%, Nasdaq +1.1% by mid-morning trading.

Analyst Perspective:

While inflation remains well above the Fed's 2% target, the resilient economy and job market support the recent rate hike. Chris Zaccarelli of Northlight Asset Management suggests improving inflation data could allow the Fed to skip meetings or raise rates less aggressively than anticipated.