The Federal Reserve’s preferred inflation gauge came in softer than expected on Friday, giving the central bank cover to begin normalizing policy and giving equity markets a fresh leg higher after a volatile week. The data reset the curve, repriced the timing of the first rate cut, and confirmed the soft-landing thesis that has been the operating assumption of the bull market since the regional bank stress of 2023 eased.
The print that reset the curve
The May personal consumption expenditures price index landed at 2.1 percent on Friday, a tenth below the 2.2 percent consensus and the lowest twelve-month reading since February 2021. Core PCE, the Federal Reserve’s preferred inflation gauge, held at 2.4 percent on a year-over-year basis. The combination of softer headline inflation alongside a still-resilient labor market and continued services spending pulled the two-year Treasury yield down nine basis points on the day to 3.96 percent, its lowest close in eleven weeks, and pulled market-implied odds of a September rate cut to fifty-eight percent from forty-three percent a week ago.
Equities price in a smoother glide path
The S&P 500 added 1.4 percent on the session, with the rate-sensitive real estate and utilities sectors leading the tape at plus 2.6 and 2.3 percent respectively. The Russell 2000 gained 2.2 percent, its best single day since the March 2024 regional bank stress. The implied volatility complex compressed: the VIX closed at 13.8, down 1.2 points, and the MOVE index fell to 91.2, a three-month low. Bank of America’s Bull and Bear indicator rose to 6.5, exiting the contrarian buy zone that the bank’s technical team had highlighted just two weeks ago. Long-duration growth stocks led the tape with the software sector up 1.6 percent and semiconductors up 2.1 percent, both priced for the discount-rate compression that follows a softer inflation print. Energy was the sole S&P 500 sector to close red, falling 0.4 percent as WTI crude broke below 81 dollars a barrel for the first time since April.
Growth slows, but the consumer is not broken
Personal income rose 0.4 percent on the month and personal spending rose 0.3 percent, both in line with expectations. Real disposable income, adjusted for inflation, advanced 0.3 percent, its third consecutive monthly gain. The saving rate held at 4.9 percent, a touch above the 4.5 percent average of the past year. Atlanta Fed GDPNow now tracks 1.6 percent for the second quarter, down from 2.1 percent at the start of the month but consistent with a non-recessionary, decelerating growth profile that historically supports the soft-landing thesis the central bank has been trying to underwrite since the 2023 tightening cycle began.
What Powell gets to say at Jackson Hole
Chair Powell now has the analytical cover to describe the disinflation process as durable without committing to a specific timing on the first rate reduction. Futures markets are pricing 48 basis points of easing through year-end, with the first cut fully priced for the September meeting. Federal funds rate futures imply a year-end target range of 4.25 to 4.50 percent, down from the current 4.50 to 4.75 percent band. The Fed’s preferred supercore services inflation measure fell to 3.2 percent year-over-year, its lowest since December 2022. The dollar index closed essentially flat at 104.1, the ten-year yield fell five basis points to 4.18 percent, and gold rose 0.3 percent to 4,317 an ounce, modest risk-on signals confirming the equity market’s read of the print.
The risk the market is not yet pricing
The next test arrives on Tuesday with the May JOLTS job openings report, followed by the ISM Manufacturing index on Wednesday and the June employment report on July fifth. A surprise re-acceleration in average hourly earnings or a re-widening of the trade deficit would force the rates market to reprice the timing of the first cut back out to the fourth quarter, and equity multiples, particularly in the long-duration growth complex, would compress at the same time the dollar index is already testing its 200-day moving average. The next seventy-two hours of data will determine whether Friday’s relief rally extends into a sustained rotation or fades into another false dawn for the soft-landing thesis.