Inflation concerns weigh on Fed's interest rate cut expectations

The upcoming inflation data is gaining increased attention in the financial world following recent signs of an unexpectedly robust economy. According to a survey of economists, analysts expect the Personal Consumption Expenditures (PCE) Index, a preferred inflation measure by the Federal Reserve, to have risen by 2.7% in August, compared to 2.6% in July. The core PCE, which excludes volatile food and energy costs, is expected to remain unchanged at 2.9% year-over-year. The Fed faces the challenge of balancing the support of the labor market through rate cuts with combating inflation. The release of the inflation data on Friday could influence expectations of rate cuts, particularly given this week's robust economic data. Notably, the unexpectedly positive GDP growth in the second quarter and the decline in initial unemployment claims could shift the dynamics. If the inflation numbers come in higher than projected, it could underscore the necessity of maintaining higher interest rates for longer. This would affect borrowing costs and keep yields on savings instruments like CDs and high-yield savings accounts elevated. Nonetheless, Fed officials emphasize that the labor market currently poses more concern than inflation. Economists predict a moderate inflation increase for the current year, driven by tariff hikes on imports. In contrast, prices in areas such as rent could rise more slowly. According to David Mericle of Goldman Sachs, inflation could climb to 3.2% by December before declining again from 2026. Richard Flax of Moneyfarm and Jeffrey Schmid of the Kansas City Fed emphasize that the current inflation rate remains above the Fed's target of 2%, which could argue against significant rate cuts in the near future. Market estimates for a rate cut in October recently fell from 92% to 85.5%, based on data from the CME Group FedWatch Tool. If the inflation figures on Friday are higher than expected, this could burden the financial markets. Daniela Sabin Hathorn of Capital.com notes that concrete evidence of easing inflation is necessary to stabilize the market. Higher inflation numbers could negatively impact the stock markets.