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After the Fed announced a rate hike earlier this month, Treasury yields surged, pushing mortgage rates and credit card rates higher in tandem. Just as the market came under pressure, investors received an unexpected gift on Wednesday: the Fed’s most closely watched inflation gauge — the Personal Consumption Expenditures (PCE) Index — came in lower than expected for August.
The data showed that August PCE rose 3.4% year over year, unchanged from July and down further from its peak of 3.8% in May. More importantly, the reading was significantly below the market expectation of 3.7%, suggesting analysts had overestimated the likelihood of future rate hikes. Excluding volatile food and energy categories, core PCE rose 3% year over year, unchanged from June and July and also below the consensus expectation of 3.3%. In other words, although the market widely expected inflation to move higher, the actual data showed inflation is stabilizing.
Sticky inflation has been the biggest reason for the Fed’s rate hikes. New Fed Chair Kevin Warsh has pledged to tame inflation, which has remained above the Fed’s 2% target for five consecutive years.
Markets quickly adjusted to the cooler-than-expected PCE data. According to futures pricing, the probability of a 25-basis-point rate hike to 4%-4.25% at the Fed’s next meeting plunged to just 37% from 51% yesterday; a week ago, that probability was as high as 70%, showing that expectations for another rate hike have cooled significantly. However, PCE is just one of several indicators the Fed will consider at its Federal Open Market Committee meeting on October 27-28.
Upcoming data also deserves attention. The September employment report will be released on Friday, and the Consumer Price Index (CPI) will be published later in October — both could influence the Fed’s decision, while the next PCE report will not come out until after the Fed meeting.
Despite the significant shift in rate-hike expectations, the stock market’s reaction on Wednesday was relatively muted. The S&P 500 was up 0.5% at midday, having briefly gotten a boost when the PCE report was first released; the Nasdaq Composite was up 0.9% over the same period. Tech stocks may also have been lifted by yesterday’s White House meeting of top AI executives, which ended with an agreement to cooperate on AI safety but produced no formal regulations.
Today’s gains show that the prospect of peak rates or no further hikes will provide support for stocks, but this is just one of many factors influencing the market, and artificial intelligence remains the most dominant force. Investors should watch Friday’s unemployment rate data and the next CPI report for more clues on whether the Fed will hike, but overall, all else being equal, cooling inflation is a bullish signal for stocks.
