PCE Inflation Falls to 3.4 Percent and the Fed Just Got Permission to Pause

The Federal Reserve's favorite inflation measure delivered welcome news this week, cooling to 3.4 percent in August and handing policymakers a reason to hold off on another interest rate hike next month.

The Personal Consumption Expenditures price index rose 3.4 percent on an annual basis in August, the Commerce Department reported, coming in well below the 3.7 percent forecast from economists polled by Reuters. Core PCE, which excludes volatile food and energy prices, rose just 0.2 percent monthly and 3.0 percent annually, beating expectations for 3.3 percent.

The surprise to the downside sent financial markets into a relief rally. Market-implied chances of a Federal Reserve interest rate increase at the October 28-29 FOMC meeting plunged from 70 percent to below 40 percent in a matter of days following the report. Gold rebounded off multi-month lows, and Treasury yields retreated from their recent peaks.

The Fed unanimously raised the target range for the federal funds rate by 25 basis points to 3.75-4.00 percent in September, marking the first rate hike since 2023. Policymakers noted that inflation remains elevated and the move aims to support a more timely return to the 2 percent target.

But the August PCE report changes the calculus heading into October. Inflation is moving in the right direction, giving the Fed breathing room to assess whether the September hike was enough to keep price pressures under control.

The cooling inflation data comes as consumer spending showed signs of strain. Real consumer spending stalled in August, suggesting that higher borrowing costs are beginning to bite. The Fed's September rate hike pushed mortgage rates above 7 percent and raised costs for auto loans, credit cards, and business financing.

Silver climbed above 61 dollars per ounce amid the easing Fed rate hike expectations. Bitcoin rallied about 7 percent in September, defying years of seasonal weakness and adding to the risk-on sentiment fueled by the softer inflation print.

The question now is whether this one month of cooler inflation is enough to convince Fed Chair Jerome Powell and his colleagues to stand pat in October. The central bank has made clear it wants to see sustained progress on inflation before declaring victory.

Markets will get another crucial data point on October 14 when the September Consumer Price Index is released. If that report also comes in softer than expected, October hike odds could fall even further. But if inflation reaccelerates, the Fed could be forced back into action.

For American consumers, the implications are immediate. The 30-year mortgage rate has retreated slightly from its recent peak above 7.19 percent as Treasury yields eased on the PCE news. Credit card rates remain near record highs, but the trajectory could shift if the Fed pivots to a pause.

The Fed's next move will be closely watched by homebuyers locked out of the market, businesses weighing expansion plans, and retirees living on fixed incomes. For now, the August inflation report offers a glimmer of hope that the most aggressive tightening cycle in decades may be nearing its end.