The Fed's favorite inflation indicator comes in below expectations; Goldman Sachs no longer expects a rate hike in October

The lower-than-expected U.S. August PCE inflation is changing Wall Street's expectations regarding the timing of the Federal Reserve's next rate hike.

Goldman Sachs on Wednesday pushed back its expectation for the Fed’s second rate hike this year from October to December, while not ruling out the possibility that the Fed may ultimately decide no further rate hikes are required.

Nick Timiraos, known as the “New Fed Whisperer,” noted that previous PPI and CPI data indicated that the improvement in inflation had not continued, and the PCE essentially did not alter this trend. Market pricing indicators remain around the 3% level before and after statistical method adjustments, meaning inflation has not made further progress toward the 2% target.

Capital Economics’ Chief North America Economist believes that core price pressures are slightly milder than previously feared, supporting a pause in rate hikes in October; BMO Senior Economist believes the proportion of PCE price components with annualized increases above 3% fell from 54% to 51%, still well above normal levels and insufficient to indicate a substantive improvement in the inflation trend.

In terms of market pricing, the Chicago Mercantile Exchange FedWatch Tool indicates that the current market-implied probability of a rate hike in October is about 39%, down from about 45% before the PCE data was released. The probability of a December rate hike has reached 90%.

As for U.S. Treasury prices, the 2-year Treasury yield dropped from 4.887% to around 4.864% after the PCE release, signaling that investors lowered bets on near-term Fed hikes, but yields subsequently rebounded to fully erase those declines. The 10-year yield continued to rise.

Meanwhile, U.S. economic data continues to show notable resilience. Second-quarter U.S. GDP growth was revised sharply upward from 1.5% to 2.2%, while August consumer spending rose 0.9%. This suggests that, while PCE has reduced the urgency for an October rate hike, it is not yet enough to fundamentally alter the inflation and economic growth scenarios that the Fed faces.

Goldman Sachs: Low Probability of an October Hike, Second Rate Hike Postponed to December

Based on inflation data released Wednesday as well as remarks by New York Fed President John Williams on Tuesday, Goldman Sachs economists adjusted their forecast for Fed policy, now projecting the second rate hike to occur in December rather than the previous forecast of October.

The Goldman Sachs economic team led by Jan Hatzius wrote in their report that the August personal income and spending data released Wednesday showed core inflation was below expectations: the monthly core PCE price index rose 0.25% and the annual gain was 3.01%, “well below expectations.”

Goldman Sachs expects the fourth quarter core PCE price index to increase by 3% year-over-year, “well below the FOMC participants’ median forecast of 3.4%.” The report stated:

“Combined with New York Fed President John Williams’ comments yesterday, we now believe a rate hike in October is unlikely; we are postponing our forecast for a second hike to December, and we think there is a significant possibility that the FOMC will ultimately determine that no further rate hikes are necessary.”

Timiraos: PCE Did Not Significantly Alter the Inflation Trend

Timiraos points out that the core message of the PCE report is that it did not significantly alter the inflation trend already understood by the market.

He believes that the June and July inflation data were favorable, but this was already known to markets; the August data shows that the improvement did not continue, which markets could already observe after the PPI and CPI data were released.

Timiraos also noted that current market pricing indicators operate around 3% before and after statistical method adjustments. Although the 12-month inflation readings do not look as bad, since April 2025, inflation has not made further progress toward the 2% target.

Other Wall Street Analysts’ Views

Capital Economics’ Chief North America Economist Stephen Brown takes a relatively dovish view on the PCE. Brown said:

“Core price pressures are somewhat lower than previously feared, which provides some support for our view that the Fed will pause rate hikes in October.”

He also noted that after the BEA revised its PCE calculation methodology, historical core inflation data were revised downward, with the revisions collectively reducing core inflation by about 0.3 percentage points; downward revisions for June and July also brought the three-month annualized core inflation down to 2%.

However, BMO Senior Economist Sal Guatieri offered a more cautious assessment, arguing that there has been no meaningful improvement in the underlying inflation trend. He said:

“The proportion of PCE price components with annualized increases above 3% has eased from 54% to 51%, but this share remains well above normal, and hardly indicates that the fundamental trend of inflation has made substantial improvement.”

Guatieri further said that this will strengthen the Fed’s view that further tightening is still necessary to return inflation to target.

In terms of market pricing, the Chicago Mercantile Exchange FedWatch Tool shows the probability of a rate hike in October is about 39%, down from about 45% before the PCE data was released. The probability of a December rate hike has reached 90%.

GDP Substantially Revised Higher, Consumption Remains Resilient

Economic data released simultaneously on Wednesday showed that U.S. second-quarter GDP growth was revised sharply higher to an annualized 2.2%, well above the previously released 1.5%.

Both major components, consumer spending and business investment, were stronger than previous values. The key measure of growth momentum—real final sales to private domestic purchasers—was also revised up to 4.6%.

The revision in investment categories highlights the driving effect of AI infrastructure development on economic growth, while the stronger consumer spending estimate suggests that, supported by a strong labor market and equity market, household finances remain generally solid.

August consumer spending increased 0.9% month-over-month, partly driven by higher gasoline spending as oil prices rose; income growth eased slightly from 0.3% in the previous month to 0.2%. The overall PCE price index rose 3.4% year-over-year, unchanged from July, while the monthly increase accelerated to 0.3%.

This article was originally published by "Wallstreet Insights," author: Chen Yang; Zhitongcaijing editor: Chen Siyu.