Dollar Rallies as PCE Inflation Runs Hot at 3.7%

The dollar strengthened across major pairs after July PCE inflation came in above consensus, cutting the odds of a September Fed rate cut.

The U.S. dollar climbed across major pairs Wednesday after July PCE inflation rose 3.7% annually, 0.1 point above consensus, prompting traders to trim dovish Federal Reserve bets.

"Today's mild upside inflation surprise and relative economic strength weren't necessarily what investors — or the Fed — wanted to see," said Ellen Zentner, chief economic strategist at Morgan Stanley Wealth Management.

The personal consumption expenditures price index rose 0.2% month over month, while the core gauge — which excludes food and energy — advanced 0.2% monthly and 3.3% annually, matching forecasts. Goods prices declined 0.1% as gasoline fell 2.7%, but services rose 0.3%, led by a 1.2% jump in financial services and insurance. Personal income increased 0.4% while consumer spending rose 0.2%, both stronger than expected.

The data complicates the Fed's path. The fed funds rate sits at 3.50% to 3.75%, unchanged since December, and markets now price roughly a one-in-three chance of a hike at the Sept. 15-16 FOMC meeting — down from 67% earlier in the month. With 10-year and 30-year Treasury yields at their highest since 2007, the dollar's strength reflects both sticky inflation and elevated term premiums.

Rate Differentials Widen as Cut Bets Fade

The dollar's advance was broad-based across EUR/USD, GBP/USD, USD/CAD, and USD/JPY as traders repriced the Fed's trajectory. The probability of at least a 25-basis-point hike in September has fallen to roughly 36% from around 67% earlier in the month, according to CME Group's FedWatch Tool. Investors still expect rates to be higher by year-end, but the latest inflation data provides no clear signal for the next meeting.

The report also showed the economy remains resilient. Q2 GDP grew at a 1.5% annualized pace, in line with expectations, while personal income and spending both beat forecasts. That combination — sticky inflation plus solid growth — gives the Fed room to keep rates restrictive without triggering a recession, which is precisely why the dollar is finding support.

The dollar's gains were not limited to a single pair. EUR/USD, GBP/USD, USD/CAD, and USD/JPY all moved in favor of the greenback, reflecting a broad repricing of the Fed's policy path rather than idiosyncratic factors in any one economy. For the euro and pound, the dollar's strength compounds the challenge of their own central banks facing similar inflation dilemmas. For the yen, the move adds pressure on the Bank of Japan to consider intervention if the dollar's ascent accelerates.

Services Inflation Keeps Pressure on the Fed

Services continue to drive price pressures. Housing costs rose 0.3% in July, while financial services and insurance jumped 1.2%. These categories are among the most persistent components of the inflation basket and the ones the Fed watches most closely for signs of stickiness. Goods prices, by contrast, declined 0.1%, helped by a 2.7% drop in gasoline and a 0.9% fall in furnishings and household equipment.

Fed Chairman Kevin Warsh is scheduled to deliver a policy speech Friday at the Jackson Hole symposium. He has remained cautious about signaling his preferred path for interest rates since taking office in May, instead allowing incoming data and financial markets to shape expectations. The PCE print, coming just days before his remarks, raises the stakes for any signal he chooses to give.

Treasury Secretary Scott Bessent recently announced plans to increase government debt buybacks, but market participants have questioned whether the initiative will meaningfully move yields. With deficits and debt supply pressure keeping term premiums elevated, any "inflation is sticky" narrative continues to support the dollar and weigh on long-duration assets.

The immediate market reaction was muted in equities — stock futures pulled back slightly after the report — but the dollar's move was more pronounced. The divergence reflects a market that is increasingly comfortable with the idea that the Fed will hold rates higher for longer, even as growth remains solid. For currency traders, the calculus is straightforward: as long as U.S. inflation stays above target and the economy keeps growing, the dollar retains its yield advantage over most major counterparts.

This article is for informational purposes only and does not constitute investment advice.