The Federal Reserve's preferred inflation gauge delivered another uncomfortable reading in late August, showing prices holding stubbornly elevated even as American consumers pulled back on spending — a combination that's raising the odds of another interest rate hike when policymakers meet later this month.

The Personal Consumption Expenditures (PCE) price index remained at 3.7 percent year-over-year in July, according to data released August 26 by the Bureau of Economic Analysis. That came in 0.1 percentage points above the Dow Jones consensus forecast and marked the second consecutive month at that level, signaling inflation's persistence despite the Fed's aggressive rate-hiking campaign.

More troubling was what happened beneath the headline number: real consumer spending — adjusted for inflation — rose less than 0.1 percent during the month, essentially flat after accounting for price increases. It's the kind of stagflation warning sign that makes central bankers nervous and investors reach for their calculators.

September Rate Hike Odds Jump

Markets responded immediately. Before the July PCE release, the CME FedWatch tool showed September rate-hike odds at roughly 33 percent. After the data hit, those odds climbed to around 40 percent as traders recalibrated their expectations for the Federal Reserve's September 15-16 meeting.

The reason is specific: the July reading confirmed that inflation has made no annual progress since June, when PCE also printed at 3.7 percent. Core PCE — which strips out volatile food and energy prices — came in slightly cooler but still well above the Fed's 2 percent target.

"This is exactly the data the Fed doesn't want to see," said Mark Zandi, chief economist at Moody's Analytics. "Inflation that won't budge combined with spending that's rolling over creates a policy dilemma — do you keep tightening into a slowing economy, or do you pause and risk letting inflation become entrenched?"

The Spending Stall

Personal consumption expenditures increased just $36.3 billion in July on a nominal basis, according to the BEA. But once inflation is factored in, that number evaporates. Real spending growth was barely measurable, suggesting American households are hitting a wall.

Personal saving remained at $712 billion in July, with the personal saving rate holding at 3.0 percent — still below pre-pandemic norms and a sign that many households have exhausted the pandemic-era savings buffers that cushioned earlier rounds of price increases.

Disposable personal income did rise 0.5 percent in July, outpacing the 0.4 percent increase in overall personal income. But that gain wasn't enough to translate into meaningful spending growth after accounting for higher prices at the grocery store, gas pump, and rent payment.

What It Means for Your Money

For consumers, the July PCE data paints a frustrating picture. Wages are rising, but not fast enough to keep pace with prices. The result is a slow erosion of purchasing power that shows up in flat real spending growth.

Mortgage rates, which had begun drifting lower in July on hopes the Fed might pivot, reversed course after the PCE release. The benchmark 30-year fixed mortgage rate climbed back above 7 percent in early September, making homeownership even more out of reach for first-time buyers.

Credit card interest rates, already at record highs above 20 percent for many borrowers, are unlikely to come down anytime soon if the Fed resumes hiking. Auto loan rates, personal loan rates, and home equity lines of credit all move in tandem with the Fed's policy rate.

The Fed's September Dilemma

Federal Reserve Chair Jerome Powell faces a delicate balancing act when policymakers gather for their September meeting. On one hand, inflation at 3.7 percent is still nearly double the Fed's target and shows no sign of declining toward 2 percent. That argues for more tightening.

On the other hand, consumer spending — the engine of the U.S. economy — is stalling. Real spending growth below 0.1 percent suggests households are tapped out. Push rates higher, and the Fed risks tipping the economy into recession.

The July PCE report offered Fed officials no easy answers. Instead, it confirmed what many economists have feared: inflation is proving more stubborn than expected, and the cost of bringing it down may be a sharper economic slowdown than anyone wants.

Markets will be watching closely when the Fed announces its decision on September 16. For now, the odds of another quarter-point rate hike have climbed to four-in-ten — uncomfortable odds for an economy already showing strain.