PCE inflation cools to 3.7% as GDP growth slows to 1.5%

The Federal Reserve's preferred inflation gauge posted its first monthly decline in four months, even as the economy lost momentum — yet policymakers signaled rates could still head higher.

The personal consumption expenditures price index fell 0.1% in June after an upwardly revised 0.5% increase in May, the Commerce Department said Thursday. On an annual basis, the PCE gauge slowed to 3.7% from 4.1%, matching economists' expectations.

"The data is largely backward-looking, since much of the decline in prices is due to a 9% drop in energy and gasoline prices in June after the US and Iran signed a ceasefire agreement that has since fallen apart," said James Okafor, macro analyst at Edgen. "Core inflation remains sticky above 3%, which gives the Fed cover to keep rates elevated."

Excluding food and energy, core PCE rose 0.1% month over month — below the 0.2% consensus estimate — and eased to 3.3% annually from 3.4%. Personal income growth slowed to 0.2% from 0.7%, while spending advanced 0.3%, down sharply from 0.9% in May.

A separate Commerce Department report showed the economy expanded at an annualized 1.5% in the second quarter, well below the 2.3% forecast and the 2.1% pace recorded in the first quarter. The moderation reflected weaker government spending, slower investment activity and softer export growth, partially offset by stronger consumer outlays. Higher imports, which subtract from GDP calculations, also weighed on the headline figure.

Why the Fed could still hike

Despite the cooling inflation and slowing growth, Federal Reserve officials have signaled they are not done tightening. The collapse of the US-Iran ceasefire agreement in recent weeks has already reversed some of the energy price declines that drove June's PCE print lower, raising the risk that inflation reaccelerates in the months ahead.

The last time the Fed faced a similar configuration — falling headline inflation alongside a deteriorating growth picture — was in late 2023, when it held rates steady through a soft-landing narrative. But the current backdrop differs: core inflation at 3.3% remains more than a full percentage point above the Fed's 2% target, and the labor market has shown few signs of cracking.

OIS markets currently price a roughly 40% probability of a quarter-point hike at the Fed's September meeting, according to CME FedWatch data. The next consumer price index release, due Aug. 13, will be the final major data point before that decision.

Cross-asset fallout

The conflicting signals have created unusual cross-asset dynamics. The 2-year Treasury yield fell 6 basis points Thursday to 4.72% as traders priced in a slightly lower peak rate, while the 10-year yield slipped 4 basis points to 4.38%. The S&P 500 edged up 0.3% as rate-sensitive technology stocks gained, though financials lagged on concerns that a slower economy will compress net interest margins.

The dollar index slipped 0.2% against a basket of major currencies, while gold rose 0.8% to $2,378 an ounce as the growth scare offset the hawkish rate rhetoric.

For investors, the key question is whether the economy is heading for a soft landing — where growth slows enough to cool inflation without tipping into recession — or a stagflationary environment where the Fed is forced to choose between fighting prices and supporting growth. The answer likely hinges on whether the energy price rebound from the collapsed ceasefire proves temporary or persistent.

This article is for informational purposes only and does not constitute investment advice.