A key measure of inflation remained well above the Federal Reserve’s target in June, while the economy expanded at a slower-than-expected rate in the second quarter — a combination that keeps pressure on policymakers as they weigh their next move on interest rates.
The Personal Consumption Expenditures (PCE) price index, the inflation measure the Federal Reserve watches most closely, rose 3.7% in June on a year-over-year basis, according to the latest data. That reading remains significantly above the Fed’s 2% inflation target, signaling that the central bank’s campaign to bring prices under control still has work to do.
PCE measures how much Americans are paying for a broad range of goods and services. The Fed prefers it over the better-known Consumer Price Index (CPI) because it accounts for changes in what people actually buy, not just a fixed basket of products. A reading of 3.7% means prices are rising nearly twice as fast as the Fed’s goal.
At the same time, gross domestic product — the broadest measure of economic output — grew at an annualized rate of 1.5% in the second quarter. That pace is below the roughly 2% rate many economists consider healthy for the U.S. economy, suggesting that higher borrowing costs are beginning to slow activity even as inflation stays stubborn.
The combination of persistent inflation and softening growth puts the Fed in a difficult spot. Raising interest rates further could cool inflation but risks dragging the economy closer to a stall. Pausing or cutting rates too soon, on the other hand, risks allowing inflation to become entrenched. Markets will look to upcoming Fed statements and economic data for clues about which concern is winning out inside the central bank.
Bond markets and equity investors tend to react quickly to PCE and GDP data because they directly shape expectations for where interest rates are headed. A higher-than-expected inflation print generally pushes Treasury yields up and can weigh on stock prices, while weaker growth can have the opposite effect on bonds. The interplay between these two forces is likely to keep markets on edge in the near term.
The next Federal Reserve policy meeting and any further inflation or labor market data will be critical in determining whether policymakers feel confident enough to hold, hike, or eventually cut rates.
