Inflation eased slightly in June, aligning with forecasts as markets anticipate a September interest rate cut, potentially just ahead of the pivotal presidential election. The personal consumption expenditures (PCE) index rose by 0.1%, meeting estimates, while the annual rate edged down to 2.5% from 2.6% in May. The core index, which excludes volatile energy and food costs, increased by 0.2% for the month after May’s 0.1% rise, but the annual core rate remained unchanged at 2.6%.
The PCE report follows the U.S. gross domestic product (GDP) estimate for the second quarter, which showed an annual growth rate of 2.8%—double that of the first quarter and significantly above forecasts. Increased consumer spending and greater business investment drove this gain.
PCE’s Significance and Fed’s Response:
While the PCE is less commonly known than the consumer price index (CPI), it is closely monitored by the Federal Reserve due to its sensitivity to short-term price movements. The Fed is set to meet next week, but most experts believe it will leave interest rates unchanged, with the first cut expected in September. Despite the downward trend in inflation, price levels remain above the Fed’s 2% annual target.
“September and December are live meetings” where a cut could occur, says Erik Aarts, senior fixed income strategist for Touchstone Investments. However, he notes that “anything more than an incremental cut means something has changed” in the economic outlook.
Friday’s report also revealed a 0.3% increase in consumer spending and a 0.2% rise in personal income. Markets responded positively, with Dow Jones Industrial Average futures climbing 225 points.
Economic Conditions and Market Reactions:
“Spending is good enough to maintain the expansion, and income is good enough to maintain spending,” said Robert Frick, corporate economist at Navy Federal Credit Union. He added that the PCE inflation level makes it easier for the Fed to decide on rate cuts. However, the low savings rate is concerning, indicating that many Americans are living on the margin.
Next week’s July jobs report from the Labor Department will provide further insights into the economy, with expectations for a gain of around 175,000 jobs. A cooling job market is anticipated by the Fed to help manage inflation.
Inflation has been a significant challenge for President Joe Biden’s administration, undermining what has otherwise been a period of remarkable economic growth, a robust labor market, and income gains. Despite the recent slowdown in price increases for key items like groceries, autos, and gasoline, the cumulative effect of high inflation over multiple years has left consumers with a sour mood.
Political Context and Economic Uncertainty:
With the presidential election just 100 days away, uncertainty surrounding the outcome—heightened by Biden’s withdrawal from the race—has left consumers cautious and businesses hesitant to expand hiring and investment. Vice President Kamala Harris, now a key figure in the campaign, has emphasized economic policies related to child care and paid family leave, which were part of Biden’s agenda but faced opposition in Congress.
Former President Donald Trump has promised to reprise his tax cut and deregulation agenda, which were the main economic achievements of his first term. He also plans to implement mass deportations of immigrants, which economists believe could lead to labor market tightness and rising inflation.
“Neither candidate seems particularly concerned about rising debts and deficits,” said Richard de Chazal, macro analyst for William Blair. With deficits running greater than 5% of GDP in the near term, bond yields are expected to be more volatile and trend higher, with a higher risk under a Trump presidency, especially with a united Congress.
The market’s positive response to the latest economic reports highlights the delicate balance between inflation management, interest rate decisions, and the upcoming election’s impact on economic policy.