At a Glance

  • Excluding volatile food and energy prices, the Federal Reserve's preferred inflation gauge rose 0.3% in September from the previous month, the largest increase since April, confirming forecasts that policymakers will cut interest rates by 25 basis points on November 7.
  • Data released by the U.S. Bureau of Economic Analysis on Thursday showed that the core Personal Consumption Expenditures (PCE) price index rose 2.7% year over year. The overall PCE price index, including food and energy, rose 2.1% over the 12-month period, slightly above the Fed's 2% target.
  • Wage and salary growth drove a 0.4% month-over-month increase in inflation-adjusted consumer spending in September, up from 0.2% in August, further confirming signs of strengthening consumer confidence.

In-Depth Analysis

Over the past month, interest rate futures traders have sharply reduced the probability of the Federal Reserve cutting rates by 50 basis points at its November 6-7 meeting from 34% to zero, according to data from the CME FedWatch tool. The Fed had already cut its key interest rate by 50 basis points in mid-September to a range of 4.75%-5%.

Traders now see a 93% probability of a 25-basis-point cut next week. The shift in market expectations coincided with surprisingly strong reports on economic and household spending data.

Data released by the U.S. Commerce Department on Wednesday showed that gross domestic product (GDP) grew at an annualized rate of 2.8% in the third quarter, following growth of 1.4% and 3% in the first and second quarters, respectively. The Atlanta Fed forecast on Thursday that the economy could expand at an annual rate of 2.7% in the fourth quarter.

Despite a cooling labor market and borrowing costs still far above the ultra-low levels of the early 2000s, consumer confidence remains strong. The Conference Board's consumer confidence index, released Wednesday, showed the largest improvement in consumer sentiment in October since March 2021.

"All five components of the index improved in October," said Dana Peterson, chief economist at the Conference Board, in a statement. "Consumers' assessments of current business conditions turned positive," she said. Their outlooks on job availability, future business conditions, and future income were all optimistic, and "for the first time since July 2023, they showed cautious optimism about future job availability."

A University of Michigan survey showed that the consumer confidence index hit a six-month high in October due to lower borrowing costs and stable inflation expectations. Consumers expect an inflation rate of 2.7% over the next 12 months, unchanged from September and within the 2.3%-3% range seen in the two years before the pandemic, said Joanne Hsu, director of the university's Surveys of Consumers, in a statement on October 25. Long-run inflation expectations fell to 3% from 3.1% in September.

Despite favorable economic data and household sentiment, Douglas Holtz-Eakin, president of the American Action Forum, said Thursday that several unresolved policy challenges complicate the Federal Reserve's efforts to exit its most aggressive tightening campaign in four decades without triggering a recession. "The near-term outlook is quite solid, and a soft landing may still be achievable," he wrote in a blog post. "But the outlook is clouded by policy risks: fights over government funding, the debt ceiling standoff, tariffs, large deficits, and the sunset provisions of the 2017 tax reform," Holtz-Eakin said. "Successfully navigating these policy risks will be key to economic performance next year."