Inflation Stalls Fed's Rate Cut Hopes Amid Tariff-Driven Price Surge

The US core Personal Consumption Expenditures (PCE) index, the Federal Reserve’s primary inflation gauge, remained at 2.9% year-over-year in July, aligning with forecasts and marking a five-month high. This reading continued to exceed the Fed’s 2% inflation target, indicating persistent price pressures in the economy despite a cooling trend since the peak of 2022. The core PCE, which excludes volatile food and energy components, was expected to rise 0.3% on a monthly basis, slightly higher than the 0.26% increase in June. Meanwhile, the headline PCE, which includes food and energy, is projected to have risen 2.6% annually for the second consecutive month.

The inflationary pressures are being fueled by the ongoing implementation of tariffs imposed by the Trump administration. These policies are contributing to upward price momentum, particularly in the goods sector, where prices have been steadily increasing at a monthly pace of 0.35–0.40 percentage points. Analysts suggest that as businesses adjust to higher costs, they are passing them on to consumers, which is elevating overall spending inflation. “That’s a big deal,” said Chris Hodge, head US economist at Natixis, emphasizing that the sustained rise in goods prices is adding upward pressure to consumer budgets.

Services inflation is also showing signs of concern. Recent data, including the Consumer Price Index, highlight rising costs in categories like shelter, airline fares, and healthcare. Services inflation is generally more persistent than goods inflation, and if these price pressures continue, they could further complicate the Fed’s inflation management. Hodge warned that if services prices remain elevated, it could signal a broader inflationary trend that would be challenging to bring back to the Fed’s 2% target.

Despite the elevated inflation data, markets remain optimistic about a Federal Reserve rate cut in September. Following a weaker-than-expected July payroll report, the probability of a 0.25-point cut at the Fed’s September meeting has climbed to 88%, according to bond futures markets. This contrasts with earlier expectations of around 62% a month ago. The dovish tone from Fed Chair Jerome Powell at the Jackson Hole symposium contributed to this optimism, as he acknowledged the shifting balance between inflation risks and labor market dynamics.

However, not all analysts share this confidence. Bank of America and Morgan Stanley have cautioned that the market may be overestimating the likelihood of an aggressive rate cut. Bank of America economists argue that core PCE inflation could continue to rise and potentially exceed 3.0% later this year, which would challenge the market’s current expectations for easing. Morgan Stanley also reduced its probability of a September cut to 50%, citing uncertainty around inflation and the Fed’s commitment to policy independence amid political pressures from the Trump administration.

Traders and investors are now closely watching the release of the July PCE data on Friday, August 29, to assess whether the Fed is likely to proceed with a rate cut in September. The data will provide crucial insight into the direction of inflation and whether it remains a key concern for policymakers. While markets have priced in a near-certainty of a September cut, the path beyond that remains uncertain, with only 42% odds of an October cut and 33% for a third move by year-end.

Gold, which is inversely correlated with the US dollar and interest rates, drifted lower ahead of the PCE release amid profit-taking and a stronger dollar. However, rising expectations for rate cuts and dovish remarks from Fed officials have limited gold’s losses. Analysts remain cautiously optimistic about gold’s longer-term outlook, particularly if the Fed moves toward a more accommodative stance. The price action above key technical indicators, such as the 100-day EMA, also supports a bullish bias.