The favorite inflation indicator for Federal Reserve officials - the core PCE inflation index, which excludes volatile food and energy components, recorded the largest monthly increase since April, and the year-on-year growth of core PCE slightly exceeded economists' general expectations, providing important evidence for the unexpected large 50 basis points rate cut by the Federal Reserve last month to slow down the pace of interest rate cuts. Combined with the previously released strong retail sales data and ADP employment data, some traders are starting to bet on the possibility of the Federal Reserve pausing the rate cut process in December.

According to the latest data released by the US Bureau of Economic Analysis on Thursday, in September, the so-called core personal consumption expenditure price index (core PCE), excluding volatile food and energy items, increased by 0.3% month-on-month, and by 2.7% compared to the same period last year. Compared to the general expectations of economists, the core PCE month-on-month increase is in line with expectations, but the core PCE year-on-year increase is slightly higher than economists' general expectation of 2.6%.

In contrast, the relatively optimistic PCE data shows that the overall PCE year-on-year increase in September was only 2.1%, hitting the lowest level since the beginning of 2021, which is basically in line with economists' expectations, just slightly above the 2% inflation target anchored by the Federal Reserve.

After the latest PCE data report was released, the three major US stock index futures continued to decline, while the 10-year US Treasury yield turned upward.

The 'mixed bag' of the PCE data report before the US election

For American voters eager to understand the economic situation before the US presidential election on November 5th, the latest PCE data report brings a mixed economic message: that while core inflation pressures still exist, consumers continue to spend, and the US economy is edging ever closer to a 'soft landing'.

After adjusting for inflation in September, real personal consumer spending accelerated by 0.4% month-on-month, slightly higher than the economists' general expectation of 0.3%. The strong growth in personal income in September played an important supportive role. The savings rate unexpectedly dropped to 4.6%, reaching the lowest level since 2023.

The PCE data released on Thursday put an end to many unexpected pleasant surprises in major economic reports over the past month. This may indicate that the Federal Reserve may adopt a cautious 25 basis point rate cut in the coming months, and may even announce a pause in rate cuts in December. Economists generally expect that after the first rate cut in September, the Federal Reserve will approve a second rate cut of 25 basis points at the end of the monetary policy meeting on November 6-7.

Inflation data for September showed that price pressures on goods and services in the United States still exist. The latest core services price index, excluding housing and energy, rose by 0.3%. The core goods prices, excluding food and energy, rose by 0.1%. Food prices rose by 0.4%, the largest month-on-month increase since the beginning of this year.

The latest consumer spending data indicates that the spending power of American consumers is stronger than expected, especially in goods consumption. The 'consumption giant wheel' accounting for 70%-80% of the US GDP continues to drive forward, combined with recent employment data showing that the US labor market remains hot, implying that the US economy is very close to a 'soft landing', with some economists even suggesting that the US economy has already achieved a 'soft landing'.

In September, the overall service expenditure, accounting for the majority of US household consumption, increased by 0.2%. Goods expenditure rose by 0.7%, and many retailers in the US have already lowered prices to attract consumers.

Before taking inflation factors into account, overall wages in the US rose by 0.5% month-on-month for two consecutive months, supporting expenditures. However, once considering factors such as the inflation rate, as well as the decline in interest and owner-type income, real disposable income only grew by 0.1%.

These data align with the preliminary forecast of the third-quarter Gross Domestic Product (GDP) released by the US Bureau of Economic Analysis on Wednesday. Preliminary data shows that with the strong consumer spending and surging defense spending driving it, the US economy's growth remains very robust.

Another set of data released by the US Bureau of Labor Statistics on Thursday showed that employment costs in the US eased slightly in the three months leading up to September, with the employment cost index rising by 0.8%, the smallest increase since mid-2021. This more moderate interpretation is consistent with Federal Reserve Chair Jerome Powell's assessment last month that 'the labor market is not the core source of rising US inflationary pressures'.

The possibility of 'pausing rate cuts' in December has entered the field of vision.

The sustained stronger-than-expected non-farm employment market and resilient consumer spending data, while greatly boosting expectations for a 'soft landing' of the US economy, have also gradually cooled down expectations of rate cuts by the Federal Reserve. Some economists state that strong economic data and unexpectedly higher inflation data may lead the Federal Reserve to pause its rate cuts process in November or December of this year, instead of continuing the cuts as expected for a long time.

Deutsche Bank recently issued a report stating that if US core PCE data continues to outperform market expectations, the Federal Reserve's 'standstill' – namely pausing rate cuts – will be fully priced in by the market. Analysts from Deutsche Bank pointed out in the report that US inflation has become more sticky, coupled with significantly easing downside risks in the labor market, making it the most powerful support for the market expectation of a 'pause in rate cuts.'

Currently, market confidence in the Federal Reserve's continued rate cuts in December is gradually weakening. A group of interest rate futures traders have started betting on a 'pause in rate cuts' by the Federal Reserve in December, even with a very small number of traders betting on the Fed pausing rate cuts in November.

Far exceeding expectations, after the release of the 'small non-farm' data - the ADP employment data, interest rate futures traders still generally bet on the Fed cutting interest rates by 25 basis points in November. However, a portion of traders have shifted to betting on the Fed announcing a 'pause to rate cuts' in December, and even fewer traders are betting on a pause to the rate cut process in November.

CME's 'Fed Watch Tool' shows that the interest rate futures market continues to bet on a 25 basis point rate cut in November, with a probability as high as 95%, but the probability of no rate cut in November has increased from 0 to 5%.

More and more traders are betting on the Fed keeping the benchmark interest rate unchanged in December. CME's 'Fed Watch Tool' shows that after the release of the far exceeding ADP employment data and the accelerating core PCE sequentially latest economic data, the probability of the Fed not cutting rates in December has jumped from 0 before the ADP data was released to over 30%, with the probability briefly approaching 40%.

Editor/Rocky