Markets now pricing in three rate cuts before the end of the year following better inflation news

A key indicator for the Federal Reserve showed that inflation eased slightly in June compared to a year ago, paving the way for a widely expected interest rate cut in September.

The personal consumption expenditures (PCE) price index rose by 0.1% for the month and 2.5% year-over-year, matching Dow Jones estimates, according to the Commerce Department's report on Friday. The annual increase was 2.6% in May, while the monthly rate remained unchanged.

Fed officials use the PCE index as their primary gauge for inflation, which continues to exceed the central bank's long-term target of 2%.

Core inflation, which excludes volatile food and energy prices, increased by 0.2% for the month and 2.6% annually, both in line with expectations. Policymakers pay closer attention to core inflation as it provides a better sense of longer-term trends, as prices for gas and groceries can fluctuate more than other items.

Stock market futures indicated a positive opening on Wall Street following the report, while Treasury yields decreased. Futures markets are anticipating a more aggressive path for Fed interest rate cuts.

“A two-word summary of the report is, ‘good enough,’” said Robert Frick, corporate economist with Navy Federal Credit Union. “Spending is good enough to maintain the expansion, and income is good enough to maintain spending, and the level of PCE inflation is good enough to make the decision to cut rates easy for the Fed.”

The report also showed that personal income rose just 0.2%, falling short of the 0.4% estimate, while spending increased by 0.3%, meeting the forecast.

As spending remained relatively strong, the savings rate decreased to 3.4%, its lowest level since November 2022.

The report comes as markets closely monitor the Fed's next moves on monetary policy.

There is little expectation that the Federal Open Market Committee will make any changes at its policy meeting next Tuesday and Wednesday. However, market pricing strongly indicates a rate cut in September, which would be the first reduction since the early days of the COVID-19 pandemic.

“Overall, it’s been a good week for the Fed. The economy appears to be on solid ground, and PCE inflation essentially remained steady,” said Chris Larkin, managing director of trading and investing at E-Trade Morgan Stanley. “But a rate cut next week remains a longshot. And while there’s plenty of time for the economic picture to change before the September FOMC meeting, the numbers have been trending in the Fed’s direction.”

After inflation reached its highest level in more than 40 years in mid-2022, the Fed embarked on a series of aggressive rate hikes, taking its benchmark borrowing rate to its highest level in around 23 years. However, the Fed has been on hold for the past year as it evaluates fluctuating data, which earlier this year indicated a resurgence in inflation but has recently shown a gradual cooling. This has led many policymakers to discuss the likelihood of at least one rate cut this year.

Futures markets have priced in about a 90% chance of a September rate cut, followed by cuts at both the November and December FOMC meetings, according to the CME Group’s FedWatch measure.