Bottom Line Up Front: With the Federal Reserve having just cut rates by 25 basis points despite inflation concerns, the September 26 PCE release will be pivotal in determining whether the Fed continues its cautious easing cycle or pauses amid persistent price pressures above the 2% target.
July’s Mixed Signals: Progress Stalled on Inflation Front
The most recent PCE data from July painted a concerning picture for Federal Reserve policymakers. Core PCE inflation rose to 2.9% year-over-year, up from 2.8% in June and marking the highest level since February 2025. This 0.1 percentage point increase represented a reversal of the disinflationary trend the Fed had hoped to maintain.
The monthly core PCE reading of 0.3% also came in line with expectations but showed persistent underlying price pressures. Meanwhile, headline PCE inflation held steady at 2.6% annually, with energy prices providing some relief by declining 2.7% year-over-year.
The composition of July’s inflation data revealed troubling dynamics. Services prices jumped 3.6% annually compared to just a 0.5% increase in goods prices, highlighting the stickiness of services inflation that has proven challenging for the Fed to address. This divergence underscores how inflation has become increasingly concentrated in the services sector, where labor costs play a larger role.
Market Implications of July’s Data
July’s PCE report had immediate consequences for monetary policy expectations. The data supported market expectations for Federal Reserve rate cuts, with analysts noting that while inflation wasn’t declining as rapidly as hoped, labor market weakness was becoming a more pressing concern for policymakers.
Ellen Zentner, chief economic strategist at Morgan Stanley Wealth Management, captured the Fed’s dilemma perfectly: “The Fed opened the door to rate cuts, but the size of that opening is going to depend on whether labor-market weakness continues to look like a bigger risk than rising inflation.”
The report also highlighted the impact of President Trump’s trade policies. The administration had imposed a baseline 10% tariff on all imports and levied additional reciprocal tariffs on multiple trading partners, with these measures beginning to work their way through the U.S. economy and contributing to price pressures.
The Fed’s September Response: A Delicate Balance
Fast-forward to September 17, and the Federal Reserve delivered its first rate cut since December 2024, lowering the federal funds rate by 25 basis points to a range of 4.00%-4.25%. The decision came despite concerns about inflation still running above target, with the Fed citing intensified worries about the U.S. labor market as the primary driver.
The vote was 11-to-1, with newly installed Governor Stephen Miran dissenting in favor of a larger 50 basis point cut. This marked less dissent than Wall Street had anticipated, as Governors Michelle Bowman and Christopher Waller, who were watched for possible additional dissents, both supported the quarter-point reduction.
The Fed’s updated economic projections revealed the challenging path ahead. Officials now expect PCE inflation to end 2025 at 3.0%, well above the central bank’s 2% target, before declining to 2.6% in 2026 and reaching 2.1% in 2027. This represents a more pessimistic inflation outlook than previous projections.
What to Expect from September’s PCE Release
The September 26 PCE data release will be crucial for several reasons. First, it will provide the first comprehensive inflation reading since the Fed’s rate cut, offering insights into whether price pressures are moderating or remaining stubbornly elevated.
Key metrics to watch:
- Core PCE inflation (year-over-year): Any reading above 2.9% would signal that inflation is not only failing to decline but potentially accelerating, which could force the Fed to reconsider its easing path.
- Monthly core PCE: A reading above 0.3% would indicate that underlying price pressures remain intense and could derail the Fed’s plans for additional rate cuts.
- Services vs. goods inflation: The composition will be critical, as persistent services inflation would suggest that labor market tightness continues to drive price pressures despite recent employment weakness.
Potential Policy Implications
The September PCE data could significantly influence the Fed’s remaining two meetings of 2025 in October and December. The Fed’s dot plot currently suggests two more quarter-point cuts this year, but there’s substantial disagreement among officials, with nine participants expecting only one more cut and one (likely Miran) advocating for much more aggressive easing.
If inflation moderates: A core PCE reading at or below 2.8% annually could provide the Fed cover to proceed with its planned easing cycle, potentially delivering cuts at both remaining meetings.
If inflation remains elevated: Core PCE at 3.0% or higher could force the Fed to pause, especially if services inflation remains problematic. This would represent a hawkish shift and could surprise markets expecting continued easing.
If inflation accelerates: Any significant uptick in core inflation could halt the easing cycle entirely and potentially trigger discussions about rate increases, though this scenario seems unlikely given labor market concerns.
Broader Economic Context
The September PCE data arrives amid a complex economic backdrop. The unemployment rate hit 4.3% in August, the highest since October 2021, while job creation has been stagnant and recent revisions showed the economy created nearly a million fewer jobs than initially reported over the 12-month period prior to March 2025.
At the same time, tariff policies continue to create upward pressure on prices, with Fed Chair Jerome Powell noting that the pass-through of tariffs has been “smaller and slower” than expected earlier this year but still contributing to inflation expectations.
Market Positioning and Expectations
Financial markets are closely watching for signs of the Fed’s future policy direction. Current projections see the fed funds rate falling to the mid-3% range by 2026, which would materially impact money market fund yields and other interest-sensitive investments.
The uncertainty around the inflation trajectory has created significant dispersion in Fed officials’ projections, making the upcoming PCE data even more critical for market pricing of future rate cuts.
Conclusion: A Pivotal Moment for Monetary Policy
The September 26 PCE release represents more than just another monthly data point—it’s a critical test of whether the Federal Reserve’s new easing cycle can proceed as planned or whether persistent inflation will force policymakers to recalibrate their approach.
With the Fed having already committed to an easing path despite inflation running well above target, the data will reveal whether this strategy is vindicated by moderating price pressures or challenged by continued inflationary momentum. For investors, businesses, and consumers alike, the implications extend far beyond monetary policy to the broader trajectory of economic growth, borrowing costs, and financial market performance.
The stakes couldn’t be higher as the Fed attempts to navigate the delicate balance between supporting a weakening labor market and maintaining credibility in its fight against inflation. September’s PCE data will provide crucial evidence about which of these dual mandate objectives should take precedence in the months ahead.
