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Fed’s preferred gauge showed core inflation at 3.0% in August, much lighter than expected
August core PCE inflation came in at 3.0% y/y, below expectations, while headline PCE rose 3.4% y/y. Spending was stronger and GDP was revised higher, but inflation still remains above the 2% target.
The Fed’s preferred inflation gauge, August personal consumption expenditures, rose 3.4% from a year earlier on the headline measure and 3.0% on core, both described as well below estimates. The monthly figures were 0.3% for headline PCE and 0.2% for core, with economists surveyed by Dow Jones expecting higher increases. The report also included methodological changes to certain components in the index construction for legal services, software and computer accessories, and portfolio management, and these revisions lowered the core July PCE level by 0.36 percentage point.
Alongside the inflation data, the Commerce Department showed spending was stronger than expected for the month, while income was described as light. Separately, second-quarter GDP was revised sharply higher, with the update attributed to higher consumer and government spending and private sales. Even with the upside surprise in growth components, the overall level of PCE inflation remains “considerably higher” than the Fed’s 2% goal, keeping open the possibility of additional hikes at later meetings.
For FX traders, the core 3.0% y/y print is a direct input into expectations for the Fed’s reaction function, influencing US yields and rate-cut versus hike probabilities that ultimately feed into USD funding and relative-rate differentials. What to watch next is whether the “higher diesel prices” referenced in market commentary show up in subsequent inflation readings, and how traders update the December versus October rate-hike probability as more data arrives.
Why this matters for FX
Lower-than-expected core PCE supports an environment where Fed rate-hike expectations can shift down, easing pressure on US real yields and overall dollar funding/financial conditions; however, the report still shows inflation well above the 2% target and GDP/spending were revised up, which can cap how far expectations move. This mix matters most for USD via interest-rate path expectations, and secondarily for cross-currency risk sentiment as global yields respond to the US inflation impulse.