Fed's favorite PCE inflation gauge likely to show slower price increases and back further rate cuts

By Jeffry Bartash

Inflation has eased in most parts of the economy except for housing

The rate of U.S. inflation using the Federal Reserve's favorite gauge is likely to show prices rising in August slightly faster than the central bank's 2% goal, but on a downward trend that justifies further cuts in interest rates.

That's the consensus of Wall Street economists ahead of the August report on consumer spending and inflation due Friday morning.

The so-called PCE index is forecast to rise 0.1% for the headline number and 0.2% for the "core" rate of inflation that subtracts volatile food and energy prices. Both readings would be roughly in line with 2% annual U.S. inflation.

"While there could be some bumps along the way, inflation now looks to be on a sustainable path to the Fed's 2% goal," economists at Nationwide wrote in a report to clients.

Some economists and the Fed's own staff believe the core rate could also rise a slower 0.1% in August. That would lend support to the central bank's decision last week to cut U.S. interest rates for the first time since 2020 by a sizable half-point.

One potential wildcard is the government's annual revision to the PCE inflation figures going back five years to 2019. Yet economists doubt they will show any big surprises.

The yearly rate of inflation, meanwhile, could decelerate to 2.3% from 2.5% and touch the lowest level since early 2021.

Some economists even predict the Fed could hit its target by next January or February.

"We anticipate [the PCE] to end the year around 2.5% before moving toward the Fed's 2% target in early 2025," said chief economist Gregory Daco of EY Parthenon.

The core rate, on the other hand, could move up from 2.6% to 2.7% in the 12 months ended in August.

Not great news, to be sure, but any negative Wall Street reaction would depend on why the rate rose.

Most likely, economists say, an increase would stem from a surprisingly sharp increase in the cost of shelter last month. But recent trends suggest that rents and housing prices have leveled off and should lead to a further easing of inflation in the months ahead.

Some top Fed officials, including Chairman Jerome Powell, believe the shelter indexes are exaggerating the rate of U.S. inflation. Housing is the single biggest component of the government's major inflation indexes.

Cooling in the shelter component of inflation, however, could be complicated by the benchmark 10-year Treasury yield's BX:TMUBMUSD10Y climb in the wake of the Fed's big rate cut.

Elevated benchmark rates might mean it takes awhile to reverse the "lock-in effect" - millions of homeowners sitting tight in their current homes after obtaining ultra-low mortgages during the pandemic.

Bret Barker, TCW's co-head of global rates, said the 10-year Treasury yield needs to sink to 3% or even lower to spur a significant refinancing wave. The current rate is 3.7%.

Yet as long as rents continue to ease, Fed officials are prepared to look past the costly shelter component in an effort to better understand the underlying rate of inflation.

"This has been something of a mystery, and I hope that some fitful and nascent signs of declines in the rate of housing price increases in the PCE index take root soon," Atlanta Fed President Raphael Bostic wrote in an essay on Monday.

Joy Wiltermuth, MarketWatch News editor and senior markets reporter, contributed to this report.

-Jeffry Bartash

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09-24-24 1525ET

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