Fed's Preferred Measure Of Inflation In Focus: How June's PCE Inflation Figure Plays Into September Rate Decision

After the July Federal Reserve meeting, which resulted in a 0.25% rate hike to a range of 5.25-5.5%, the market will have about two months to examine incoming economic data that will be critical for the Fed’s future interest rate decisions.

On Thursday, the second-quarter advanced GDP statistics revealed an unexpected expansion (+2.4% quarter-on-quarter annualized), exceeding analysts’ expectations of 1.8%.

However, the June Personal Consumption Expenditure (PCE) price index report, the Fed’s favored gauge of inflation, will be the primary focus of both the central bank and financial markets on Friday.

The PCE report will be published by the Bureau of Economic Analysis on July 28 at 08.30 a.m ET.

June PCE Inflation Report: What is The Market Expecting?

The headline PCE inflation is expected to drop from 3.8% in May to 3% in June, the lowest since March 2001. In monthly terms, the PCE inflation is expected to advance 0.2% in June, accelerating from the 0.1% growth in May.
If the data aligns with economists’ estimates, the annual PCE inflation rate would match the June’s consumer price index (CPI) inflation rate.
Since February 2001, however, the annual PCE inflation rate has consistently been lower than the CPI inflation rate each month.

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Chart: PCE Inflation Has Been Consistently Lower Than CPI Inflation Since February 2001

Core PCE inflation, which excludes energy and food items, is expected to decline from 4.6% to 4.2% year-on-year in June. On a monthly basis, the core PCE inflation is expected to advance 0.2% in June, decelerating from the 0.3% rise in May.
This would mark the lowest level for core PCE inflation since October 2021. In June, the core CPI inflation rate plummeted from 5.3% to 4.8%.
If the data aligns with economists’ estimates, the core PCE inflation rate would be 0.6 percentage points lower than the core CPI inflation rate seen in June.

Chart: Core PCE Inflation Is Expected To Drop To 4.2% In June 2023

Potential Reactions On Market Rate Expectations

The PCE inflation data will be crucial in confirming whether the ongoing disinflation trend remains well-defined across various economic indicators.

However, this will be just one of the many economic data prints that the Fed and the market will have to digest before the Federal Reserve’s meeting on September 20. Two more CPI reports and two jobs reports are scheduled to be released before that date.

Nonetheless, Friday’s PCE data can influence market expectations on interest rates, as reflected by Fed futures.

Currently, traders assign a 24% probability of a 25-basis-point rate hike in September and a 38% probability of a hike by the November meeting.

A lower-than-expected PCE inflation figure (3%) could dampen expectations for future rate hikes, while a smaller decline than anticipated may maintain or slightly raise these expectations.

Of particular interest will be the core PCE inflation, a measure closely watched by the Fed, and whether it is trending down in line with expectations (4.2%). June saw a significant drop in core CPI inflation, and it will be important to see if the same holds true for the core PCE inflation.

The iShares Treasury Inflation Protected Securities (TIPS) Bond ETF TIP, one of the preferred assets to shield against inflation surprises, currently trades about 18% lower than its 2022 highs.

Chart: Inflation-Linked U.S. Treasuries Tumbled 18% Since 2022 Highs As Inflationary Pressures Faded