U.S. August PCE: Inflation Cooled, Edging Closer to the Fed's Target

Economic

Data Interpretation

Summary:

The U.S. Department of Commerce released data on September 27 showing that the U.S. overall PCE price index rose 2.2% YoY in August, the lowest level since February 2021, compared with expectations of 2.3% and the previous reading of 2.5%. With inflationary pressures weakening, the market is warming up to expectations of a sharp rate cut in the future.

On September 27, local time, the U.S. Bureau of Economic Analysis (BEA) released its latest PCE report:

Core PCE for August came in at an annual rate of 2%, compared to the expected reading of 2.5% and the previous reading of 2.6%.

Core PCE for August came in at a monthly rate of 0.1%, compared to the expected reading of 0.2% and the previous reading of 0.2%.

PCE for August came in at an annual rate of 2.2%, compared to the expected reading of 2.3% and the previous reading of 2.5%.

PCE for August came in at a monthly rate of 0.1%, compared to the expected reading of 0.1% and the previous reading of 0.2%.

The data indicates that the overall PCE price index in the U.S. increased by 2.2% YoY in August, marking the lowest level since February 2021, with a MoM rise of 0.1%, which aligns with market expectations. The core PCE price index also rose by 2.7% YoY, completely in line with market estimates, while the MoM growth was 0.1%, the lowest since May.

Breaking it down by components, personal income saw an increase of US$50.5 billion in August, representing a 0.2% MoM growth. Personal consumption expenditures rose by US$47.2 billion, also increasing by 0.2% MoM, with service expenditures up by US$54.8 billion and goods expenditures falling by US$7.6 billion.

In the services sector, the largest contributors to growth were housing, financial services, and insurance. Housing-related cost pressures persist, with a YoY increase of 0.5% in August, the largest rise since January. Overall service prices rose by 0.2%. In the goods sector, prices dropped by 0.2%, with the primary driver being a decrease in expenditure on new motor vehicles. Additionally, food prices increased by 0.1%, while energy prices fell by 0.8%.

In September, the Federal Reserve significantly cut interest rates by 50 basis points, officially commencing a new round of monetary easing. Given that PCE data, which is favored by the Fed as an inflation indicator, continued to show cooling in August, this is likely to bolster the Fed's confidence in further rate cuts. Following the data release, market expectations for substantial future interest rate reductions have intensified.

U.S. August PCE

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Economic

Will the Fed opt for a back-to-back 50bps rate cut?

Although the dollar slipped after the Fed decided to cut interest rates by 50bps and to signal that another 50bps worth of reductions are on the cards for the remainder of the year, the currency traded in a consolidative manner last week even with market participants penciling around 75bps worth of cuts for November and December. A back-to-back double cut at the November gathering is currently holding a 50% chance according to Fed funds futures.

Ergo, with policymakers Christopher Waller and Neel Kashkari clearly favoring slower reductions going forward, the current market pricing suggests that there may be upside risks in case more officials share a similar view, or if incoming data corroborates so.

This week, investors will have the opportunity to hear from a plethora of Fed members, including Fed Chair Powell on Monday, but given that the dot plot is already a relatively clear guide of how the Fed is planning to move forward, incoming data may attract more attention, especially Friday’s nonfarm payrolls.

ISM PMIs and NFP report to attract special attention

But ahead of the payrolls, the ISM manufacturing and non-manufacturing PMIs for September, on Tuesday and Thursday respectively, may be well scrutinized for early signs of how the world’s largest economy finished the third quarter. If the numbers agree with Powell’s view after last week’s decision that the economy is in good shape, then the dollar could gain as investors reconsider whether another bold move is necessary.

However, for the dollar to hold onto its gains, Friday’s jobs report may need to reveal improvement as well. Currently, the forecasts are suggesting that the world’s largest economy added 145k jobs in September, slightly more than August’s 142k, with the unemployment rate holding steady at 4.2%. Average hourly earnings are seen slowing somewhat, to 0.3% m/m from 0.4%.

Overall, the forecasts are not pointing to a game-changing report, but any upside surprise coming on top of decent ISM prints and less-dovish-than-expected commentary by Fed policymakers could very well act as the icing on the cake of a bright week for the US dollar. Wall Street could also cheer potentially strong data, even if it translates into slower rate cuts ahead, as more evidence that the US economy is not heading into recession is nothing but good news.

Eurozone inflation in focus amid split ECB

In the Eurozone, the spotlight is likely to fall on the preliminary CPI data for September, due out on Tuesday. Even though Lagarde and her colleagues did not offer explicit signals regarding an October reduction, the disappointing PMIs encouraged market participants to increase bets of such an action. Specifically, the probability of a 25bps reduction at the October 17 meeting is currently at around 75%.

Having said that though, a Reuters report citing several sources noted yesterday that the October decision is seen as wide open. The report mentioned that the doves will fight for a rate cut following the weak PMIs, but they will likely face resistance from the hawks, who will argue for a pause. Some sources are talking about a compromise solution in which rates are kept on hold but reduced in December if data doesn’t improve.

Yet, the market’s base case scenario is rate cuts in both October and December, and a set of CPI numbers pointing to further slowdown in Euro area inflation could solidify that view.

Euro/dollar could slip in such a case and extend its decline if the US data corroborates the notion that there is no need for the Fed to continue with aggressive rate reductions. That said, for a bearish reversal to start being considered, a decisive dip below the round figure of 1.1000 may be needed, as such a break may confirm the completion of a double top formation on the daily chart.

BoJ’s Summary of Opinions also on the agenda

In Japan, the BoJ releases the Summary of Opinions from the latest decision, where policymakers kept interest rates unchanged but revised up their assessment on consumption due to rising wages. Governor Ueda said that they will keep raising rates if the economy moves in line with their outlook and thus, investors may dig into the summary for clues and hints on how likely another rate hike is before the end of the year.

Japan’s employment data for August, due out during the Asian session Tuesday, and the Tankan survey on Thursday, may also help in shaping investors’ opinion.

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WELLS FARGO

Economic

United States: Consumer in the Spotlight

The personal income and spending data this week show that inflation remains in check, shed light on the staying power of the consumer and paint a more constructive backdrop for household finances moving forward. Real estate should be a beneficiary of lower interest rates as the Fed eases policy, yet housing activity remains slow.

This week: ISM Manufacturing (Tue.), ISM Services (Thu.), Employment (Fri.)

International: Eurozone Economy at Risk of Renewed Stumble

The Eurozone September manufacturing and services PMIs were disappointing, with output and orders both softening, although they also indicated an overall softening in price pressures. We expect Eurozone expansion to continue, but now expect a slower pace of recovery than previously. Elsewhere, last week was a busy week for international central banks. China, Sweden, Switzerland, Hungary, the Czech Republic and Mexico all lowered interest rates, while Australia held monetary policy steady.

Credit Market Insights: Is the Tide Turning for Commercial Real Estate?

When the Fed cut the policy rate by 50 bps, it marked what should be the beginning of the end of the worst CRE downturn since the global financial crisis. Although there are no shortage of obstacles ahead for CRE, the gap between the amount of maturing debt in need of refinancing and the available capital should be reduced with lower rates, thus limiting the extent to which stress mounts further.

Topic of last Week: Reasons Not to Panic About Looming Port Strikes

Thousands of dockworkers are set to strike at East and Gulf coast U.S. ports this week if the International Longshoremen’s Association (ILA) and the United States Maritime Alliance (USMX) cannot come to an agreement regarding wage negotiations. While work stoppages at these ports cannot be ruled out, and a prolonged worker stoppage could disrupt supply chains, our sense is that worries about major supply disruption are overstated.

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TD Securities

Economic

The Canadian economy grew by 0.2% month-on-month (m/m) in July after June’s flat reading. This print landed ahead of Statistics Canada’s advanced guidance and consensus expectations. Early guidance from Statistics Canada points to no growth in August.

May’s reading was broad-based, with output expanding in 13 of 20 industries. Growth in services-producing industries (0.2% m/m) advanced at a slightly faster pace than in goods-producing industries (0.1% m/m).

On a weighted basis, the retail trade sector contributed most to the overall gain in July’s GDP, and was up for a second consecutive month (+1.0% m/m). Elsewhere on the services side, gains in the finance and insurance industry (+0.5% m/m) and the public administration sector (+0.4% m/m) were offset partially by a drag in the transportation sector (-0.4% m/m) that were impacted by wildfires.

On the goods side, utilities (+1.3% m/m) did most of the heavy lifting on the back of increased demand for electricity. Meanwhile, the manufacturing sector reversed some of last month’s slide and the construction sector slumped for a third straight month, down 0.4% m/m.

Behind the advanced reading of stalled growth in August is an increase in oil & gas and public sector activity offset by pullbacks in the manufacturing and transportation & warehousing sectors.

Key Implications

GDP data for July came in stronger than expectations, but the momentum should be short-lived. With the current guidance for flat industry-GDP growth next month, third quarter GDP is tracking just north of 1.0% quarter-on-quarter (q/q) annualized, significantly below the Bank of Canada’s (BoC) 2.8% forecast, but broadly in line with our recent forecast update.

The BoC next rate decision is in late October and more cuts are certainly on the table. The BoC has shifted their tone as of late, putting more emphasis on their fears around a weakening economy. For what it’s worth, we don’t think the data tips the scales any more-or-less in favour of a potential 50 basis point (bps) interest rate cut, which would follow the recent move from the Federal Reserve. Instead, more emphasis will be placed on upcoming labour market data as well as inflation data, where the Bank will be looking for signs that price growth can remain durably at 2%.

To stay updated on all economic events of today, please check out our Economic calendar

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Bruegel

Energy

Economic

Energy cooperation

Despite Brexit, the European Union and United Kingdom remain linked through energy. In 2023, trade in energy accounted for 10 percent of EU-UK trade, and energy accounted for 20 percent of the UK’s exports to the EU. The UK is a major supplier of crude oil to the EU with around €1 billion in exports monthly. Increased exports of natural gas and electricity from the UK into north-west Europe were essential for surviving the winter 2022-23 energy crisis (Figure 1).

Identifying Areas for EU-UK Energy and Climate Cooperation_1

This post-Brexit bilateral relationship is based on the Trade and Cooperation Agreement (TCA), signed by the EU and the UK in May 2021 . It includes specific provisions on electricity and natural gas trade that have so far sustained cross-border energy flows in those commodities. However, the temporary nature of these trading arrangements weakens the business case for British and European companies to make clean energy investments. Establishing a more solid relationship on energy has also been hampered by political red lines, with UK policymakers keen to avoid any notion of ‘rejoining’ elements of Brussels bureaucracy and European policymakers keen to dispel the notion that the UK, having left the single market, can pick-and-choose areas for policy alignment.

The change in UK government in July 2024 may enable an improvement in energy trading relations with the EU. On energy and climate policy, the UK and EU have more in common than differences, and deeper cooperation can be mutually beneficial. The shared renewable resource in the North Sea means cooperation can lower the cost of the energy transition for both.

Deeper cooperation can be realised through a series of bespoke arrangements. First, the current temporary electricity trading arrangements should be agreed and finalised. Second, trade disruptions arising from carbon border tariffs should be mitigated, especially when the results might be counterproductive. Third, the UK and EU should approach climate policy – on which they share similar ambitions – as an area for cooperation on the international stage to leverage shared goals.

Deeper cooperation will enable a smoother energy transition

The main opportunity for deeper cooperation on energy is with electricity. Cooperation should be framed by three related aims:

Constructing new electricity infrastructure;

Ensuring the physical security of that infrastructure;

Facilitating efficient electricity trade via that infrastructure.

A shared priority is the development of electricity infrastructure to exploit the huge offshore wind potential of the North Sea, which could meet 45 percent of the electricity demand of North Sea countries by 2050 (Danish Energy Agency, 2022). Making full use of these renewable resources will require generation and interconnection capacity to be built and hybrid energy projects to be carried out . Cost savings and less reliance on fossil fuels can be realised by distributing and interconnecting generation capacity across the North Sea, smoothing the output from variable renewables to more efficiently balance supply and demand (Zachmann et al, 2024).

The UK currently has 9.8 gigawatts (GW) of interconnection capacity with European countries, approximately one fifth of its peak demand. This is a relatively high degree of physical integration, given that EU countries have a target of 15 percent interconnection capacity relative to peak demand by 2030. Approval has been granted for another 4.4 GW of interconnection capacity between the UK and the EU . Figure 2 shows existing and planned interconnectors, existing offshore wind capacities and targets for 2030.

Identifying Areas for EU-UK Energy and Climate Cooperation_2

As the North Sea becomes a major energy resource for Europe, the physical security of infrastructure will become increasingly important for energy security. Explosions on the Nord Stream pipeline and damage to energy infrastructure in the Baltics demonstrate the material risks.

Political dialogue on the North Sea

The North Seas Energy Cooperation (NSEC) is a collaboration between EU countries in the region to develop the offshore grid and renewable potential in the North Sea. The UK left NSEC after Brexit, but a memorandum of understanding between NSEC participants and the UK was signed in December 2022 to establish core areas of cooperation, including hybrid projects, planning, finance and knowledge sharing. The Ostend Declaration , a non-binding agreement between North Sea countries, followed in 2023, laying out plans to expand offshore wind capacity and transmission infrastructure. A target was set to quadruple current offshore wind capacity in the North Sea to 120 GW by 2030, and to increase it by a factor of ten, to 300 GW, by 2050. Such agreements signal a common level of ambition, yet substantially more concrete commitments and policy detail are needed on the regulatory regime for North Sea offshore wind projects (Tagliapietra, 2023).

Policy design risks impeding efficient investments and trade

After the UK’s exit from the EU’s integrated wholesale electricity markets at the end of the Brexit transition period in January 2021, electricity trading across interconnectors in the Channel and the North Sea reverted to a less-efficient arrangement . Current rules are sufficient to ensure security of supply but may inhibit the development of shared assets in the North Sea.

The TCA committed to establishing a more integrated trading model, yet finalised arrangements have yet to materialise . For offshore wind developers and their financiers, it is presently unclear what future trading regime they will be subject to. If divergent arrangements persist, hybrid offshore wind projects will face the administrative burden of simultaneously operating in separate regulatory zones, potentially increasing costs or slowing down project development.

National Grid, the UK’s transmission system operator, has stated its desire to rejoin fully the EU’s integrated wholesale markets. Full participation would be economically optimal for both parties and would minimise regulatory uncertainty for offshore wind projects. The full integration of non-EU member Norway into the EU’s electricity markets demonstrates that extra-EU arrangements for integrated electricity trading are feasible.

The EU concluded an electricity market reform in 2024, while the UK at time of writing is assessing consultation responses to its own reform proposals. Both jurisdictions should consider regulatory compatibility in any future market design changes.

Climate cooperation: aligned ambitions

On climate policy, the EU and the UK have similar ambitions. Progress has also been broadly similar judged by reductions in greenhouse gas emissions per capita, reduced carbon intensity of electricity generation and increased electric vehicle registrations (the UK is marginally ahead on all three; Figure 3). The TCA includes a commitment to ‘non-regression’, committing both parties to not reduce current levels of climate ambition and to support the goals of the Paris Agreement.

Identifying Areas for EU-UK Energy and Climate Cooperation_3

Avoid regulatory-driven disruptions

But while ambitions are aligned, policies are, and will likely continue to be, different. A case in point is the introduction of separate EU and UK carbon border adjustment mechanisms (CBAMs). These mechanisms impose a carbon price at the border for imports that are not subject to domestic carbon prices. The tariff is waived or reduced if imports come from a region that imposes a commensurate carbon price. The EU CBAM has already entered its implementation phase, while the UK CBAM is set to be introduced in 2027.

The EU and UK have very similar carbon cap-and-trade pricing schemes, with the UK largely replicating the EU system since Brexit. However, prices are determined by domestic markets and the differential between EU and UK prices has fluctuated substantially (Figure 4). These fluctuations might require UK exporters that sell to the EU and EU exporters that sell to the UK to pay additional tariffs. A non-tariff barrier to trade is also created owing to the administrative burden of calculating and complying with the regulation.

Identifying Areas for EU-UK Energy and Climate Cooperation_4

For industrial goods including steel and chemicals, this creates a trade barrier but does have some rational climate justification. For the trade in electricity, the situation is different. The EU’s CBAM methodology for assessing the carbon content of imported electricity is based on historical average grid emissions. However, UK exports into the EU (or vice versa) occur during periods of excess electricity generation, which typically means high renewable output and significantly lower than average historical emissions. Without careful design and implementation, a well-intended CBAM might penalise the export of renewable electricity and increase emissions. AFRY (2024) found that the EU CBAM introduction in 2026 would lead to greater curtailment of renewable electricity and a net increase in annual carbon emissions.

An obvious solution to this would be for the UK to rejoin the EU’s emissions trading system – which originates from the system designed by the UK in 2002. Logistically, this is feasible, because the EU and UK systems have remained essentially identical and non-EU members Iceland, Liechtenstein, Norway and Switzerland already participate in the EU ETS. Politically, it might be more difficult, as with electricity market integration, because of the UK reticence about being seen to rejoin EU mechanisms. A solution is needed to at minimum resolve adverse electricity trading outcomes.

Two future areas for possible expanded cooperation are carbon dioxide storage and critical mineral supplies. The North Sea has significant potential for sequestering carbon, while ensuring the supply of critical raw materials – relevant especially for clean-tech supply chains – is a priority for both the EU and the UK.

Leverage aligned climate ambitions on the international stage

Climate cooperation at international level is particularly relevant, as all countries are required to submit their updated nationally determined contributions (NDCs) ahead of the United Nations climate summit (COP30) in 2025. The NDCs will outline national emissions-reduction plans up to 2035 and will largely determine whether the world can get onto an emissions trajectory in line with the goals of the Paris Agreement. These updates have been called by the UNFCCC “the most important documents to be produced in a multilateral context so far this century”.

The EU and the UK could jointly play an important role in fostering global momentum for this new round of NDCs and might also make a joint diplomatic push to turn these new NDCs into comprehensive national green transition plans, integrating concrete projects and initiatives. By linking these plans to climate finance disbursement, particularly in emerging markets and developing economies, incentives can be created for robust development and implementation. This linkage will ensure that financial support is aligned with the priorities outlined in NDCs, facilitating effective climate action.

The EU and UK are also important players in Just Transition Partnerships (JETPs), launched at COP26 in 2021 to provide tailored financial assistance to specific countries, combining public and private funding from G7 countries to support power-sector decarbonisation strategies. The EU and the UK are among the main funders of JETPs, alongside the United States and development banks, and can thus help in fostering their development and increasing their effectiveness. JETPs are currently hampered by inadequate funding and a lack of explicit policy-action links. They also need improved governance and monitoring frameworks (Bolton et al, 2024).

Conclusions

In energy and climate policy, cooperation offers mutual benefit to the UK and EU, making it a strong contender for helping rebuild the post-Brexit relationship. The focus should be on three areas: efficient electricity trading, resolving CBAM trade barriers and leveraging shared climate ambition and similar policies in an international context.

Treated in isolation as techno-economic problems, solutions in these areas seem feasible. The real challenges stem from broader political discourse and negotiations between the EU and the UK. For the UK, any agreements must avoid connotations of rejoining the EU. While for the EU, bespoke arrangements must avoid the notion of the UK ‘cherry picking’ policies.

To stay updated on all economic events of today, please check out our Economic calendar

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UBS

Economic

Real estate

Investors waiting in the wings

The last two years have been testing for real estate investors. But there are now numerous signs of recovery taking place in selected market areas. Transaction volumes are flattening and, in the UK, where valuations tend to be adjusted relatively quickly to transaction market data, investment volumes are already rising anew. The marginal improvement indicates that we have passed the bottom of this cycle in terms of investment volume.

While the gap between transaction prices and book values is slowly closing, investors in many markets are still on hold, waiting for the anticipated rate cuts to come into effect. After the first cut in June, the European Central Bank (ECB) cut its rates by another 25bps on 12 September. In view of continuously calming inflation pressures and the slowdown of the US labor market, the Fed cut its policy rates by 50bps on 18 September. The Bank of Canada made a total of three cuts of 25bps each so far in 2024, and the Bank of England cut by 25bps in early August.

With the decline in inflation and the flattening if not the outright drop in long-term interest rates, the pressure on property yields has diminished significantly. They are now flattening in most markets, consequently bringing us to the end of the capital value correction phase. Paris CBD prime offices even saw a marginal (-25bps) yield compression in September compared to August.

However, while real estate prices are expected to recover, appreciation gains in line with those during the time of low or negative interest rates, which were associated with strong investment pressure, are unlikely in the short to medium term. This makes the income return (i.e., rental income) more important as a proportion of total returns and puts segments or markets, where leasing fundamentals are favorable, into the center of attention. We continue to favor segments that are displaying shortage of supply, such as residential, as well as those profiting from structural economic changes, such as logistics.

Infrastructure

Are the stars aligning for private infrastructure?

The Fed’s decrease in rates follows the action of other central banks, which have already started reducing interest rates earlier in the year. Although the future pace of rate cuts around the world will not be as dramatic, this should at least give infrastructure investors some comfort that financing markets will improve steadily, and important consideration given infrastructure assets tend to employ high levels of leverage.

We have previously highlighted that private infrastructure tends to perform well during inflationary environments, since infrastructure typically consists of hard assets that have strong pricing power. Although inflation has slowed down significantly, it is still higher than the 2% target that many central banks have adopted. Meanwhile, GDP growth is also holding up, and has even exceeded consensus expectations from a year ago in some markets (i.e., US and UK).

In other words, we are seeing elevated inflation, higher than expected GDP growth, the beginning of a new rate-cut cycle, and an improvement in overall sentiment for infrastructure. Combined with secular tailwinds from decarbonization, digitalization, deglobalization and demographic change, widespread government support for infrastructure, and continued fiscal strain of governments opening up opportunities for the private sector, the stars appear to be aligning for private infrastructure investors.

Private equity

Rate cuts could jump start exits

The Fed’s decision to cut interest rates could be just what private equity needs to break out from its exit slump.

Higher borrowing costs have weighed on private company performance, but especially exits, since rate increases began in 2022. As interest rates rose, more equity has been required to finance deals, putting downward pressure on returns. Prospective buyers of private companies reacted immediately, demanding compensation in the form of lower purchase prices; many sellers decided to wait for better pricing. The result has been declining deal activity in 2022, 2023, and 2024.

We believe the Fed’s rate cut and guidance to expect more of the same in the coming quarters has the potential to significantly boost deal activity, particularly due to the Fed’s position as the most influential and widely followed central bank (the ECB also cut rates for the second time in September).

A recovery in private equity deal activity and buoyant public markets could also combine to boost fundraising activity. Still, we believe gains may flow to large and established managers, who have taken a larger share of LP capital in recent years.

Transaction activity remains robust; co-investment dynamics favor LPs, especially those already partnered with high-quality sponsors as primary investors. Secondary deal-flow is especially active, and while discounts have closed somewhat (especially for high-quality LP interests), today’s market holds plenty of opportunities for selective investors.

Private credit

Lower rates and impact on residential real estate credit

With the Fed’s recent announcement, the rate cutting cycle has officially commenced in the US. This dynamic should largely be beneficial from a credit perspective as corporate borrowers, real estate owners, small businesses, and consumers will likely have the opportunity to refinance recently originated fixed rate debt at a lower cost of capital in the coming quarters.

Furthermore, borrowers with floating rate debt will experience an immediate relief in borrowing costs as the base rate declines. While the lower rate trajectory is expected to be positive from a credit perspective, there will likely be various impacts on residential real estate and the various asset classes associated with the sector.

As it pertains to residential fundamentals, lower interest rates should positively impact the market. Lower mortgage rates will improve affordability for borrowers through lower borrowing costs and potentially increase demand for housing. This should provide further stability for home prices and all be a credit-positive event for transition lending and project finance strategies.

It is worth noting that lower interest rates could also bring more supply to the housing market. The US residential market has contended with depressed levels of existing home sales due to constrained supply in many markets, which has been driven by the lock-in effect caused by the spike in mortgage rates. As mortgage rates decline, the lock-in effect becomes less impactful for certain existing homeowners and could lead to more existing homes going for sale. Ultimately, lower rates is positive for home prices given the improvement in affordability. However, there could be greater dispersion in terms of home prices by market, as increases in homes available for sale could cause home price growth to be weaker than expected.

Finally, the decline in mortgage rates will also have an impact on prepayment speeds. It will likely result in prepayment speeds increasing compared to what has been observed over the past two years. Specifically for securities investments, faster prepayment speed is positive for legacy, discount dollar price bonds and negative for mortgage derivatives.

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