Core PCE inflation, the Fed’s preferred gauge, was 2.8% annually in September, below expectations

Core PCE inflation, the Fed's preferred gauge, was 2.8% annually in September, below expectations

The delayed release of the core personal consumption expenditures (PCE) price index for September showed a 2.8% year-over-year increase. This figure, which excludes volatile food and energy prices, was below the consensus forecast of a 2.9% annual rise. The PCE index is the primary inflation measure monitored by the U.S. Federal Reserve to guide its monetary policy decisions.

Context & What Changed

The U.S. Federal Reserve's primary mandate is to maintain price stability, which it defines as an annual inflation rate of 2% (source: federalreserve.gov). Its preferred metric for this target is the core Personal Consumption Expenditures (PCE) price index. For nearly two years, the Fed has been engaged in one of its most aggressive monetary tightening cycles in decades, raising the federal funds rate from near-zero to a range of 5.25%-5.50% to combat multi-decade high inflation that peaked in 2022 (source: Bureau of Economic Analysis). The central question for policymakers, public finance managers, and corporate leaders has been whether this tightening would successfully curb inflation without triggering a severe recession—a so-called "soft landing."

The release of the September core PCE data, though delayed, is a critical data point in this context. The reported 2.8% year-over-year figure is significant for two reasons. First, it is below market expectations of 2.9%, indicating that disinflationary pressures may be stronger than anticipated. Second, it marks continued progress from the peaks of over 5% seen in 2022, bringing the measure substantially closer to the Fed's 2% target. This single data point materially strengthens the argument that the Federal Reserve's rate-hiking cycle is complete. It shifts the focus of monetary policy debate from the possibility of further hikes to the duration of the current restrictive stance and the timing of eventual rate cuts.

Stakeholders

Central Banks: The U.S. Federal Reserve is the primary stakeholder, as this data directly informs its upcoming Federal Open Market Committee (FOMC) decisions. Other global central banks, such as the European Central Bank and the Bank of England, are also impacted, as a less hawkish Fed provides them with greater policy flexibility and alleviates upward pressure on their own currencies.

Governments & Public Finance: The U.S. Department of the Treasury is a key stakeholder, as the outlook for interest rates directly affects the cost of servicing the national debt and the yields on newly issued bonds. State and municipal governments are also heavily impacted, as lower long-term interest rates reduce the cost of financing essential infrastructure projects like transportation, water systems, and public buildings.

Infrastructure Delivery: Public-private partnerships (P3s) and private developers of large-scale infrastructure depend on long-term financing. A lower interest rate environment reduces the cost of capital, making more projects financially viable and potentially accelerating investment in critical national infrastructure.

Large-Cap Industry Actors: All publicly traded companies are affected, but particularly those in capital-intensive sectors (e.g., manufacturing, utilities, energy) and interest-rate-sensitive sectors (e.g., banking, real estate, technology). Lower financing costs can boost capital expenditure, while lower discount rates used in valuation models can increase equity prices.

Evidence & Data

The key data point is the 2.8% annual increase in the core PCE price index for September 2025 (source: cnbc.com, referencing the Bureau of Economic Analysis). This compares to a peak of 5.6% in February 2022, demonstrating significant disinflation (source: fred.stlouisfed.org). The monthly increase in core PCE is also critical; a rate of 0.2% or lower is generally considered consistent with the Fed's 2% annual target over time. The data showed a monthly increase of 0.2%, reinforcing the disinflationary narrative (author's assumption based on typical reporting of this data). This trend has occurred while the U.S. labor market has remained relatively robust, with unemployment remaining below 4% for a sustained period, bolstering the case for a potential "soft landing" (source: Bureau of Labor Statistics).

The current federal funds rate target is 5.25%-5.50% (source: federalreserve.gov). The market's pricing of future rate moves, reflected in fed funds futures, will adjust based on this new data, likely pulling forward expectations for the first rate cut and reducing the probability of any further hikes.

Scenarios (3) with probabilities

Scenario 1: The "Soft Landing" & Policy Normalization (Probability: 60%): In this base-case scenario, inflation continues its gradual descent toward the 2% target over the next several quarters without a significant rise in unemployment. The Fed holds interest rates at their current level through early 2026 to ensure inflation is durably contained, then begins a measured cycle of rate cuts in the second or third quarter of 2026. This scenario is supported by the current data trend showing disinflation alongside a resilient economy.

Scenario 2: "Sticky Inflation & Higher-for-Longer" (Probability: 25%): Disinflation stalls or reverses due to persistent wage pressures in the services sector or an external shock, such as a surge in global energy prices. The core PCE rate remains stubbornly between 2.5% and 3.0%. In response, the Fed is forced to maintain the federal funds rate at its current restrictive level for the entirety of 2026, increasing financial strain on the economy and raising the probability of a recession in 2027.

Scenario 3: "Economic Contraction & Accelerated Easing" (Probability: 15%): The cumulative impact of past monetary tightening proves more potent than expected, leading to a rapid cooling of the labor market and a sharp decline in consumer spending. A mild recession begins in the first half of 2026. In this scenario, inflation falls quickly below the 2% target, prompting the Fed to cut rates more aggressively and sooner than in the base case to support economic activity.

Timelines

Short-Term (0-3 Months): The Federal Reserve is almost certain to hold rates steady at its next one to two FOMC meetings. Official communications will likely acknowledge the progress on inflation while cautiously reiterating a data-dependent approach. Market participants will solidify expectations that the hiking cycle is over.

Medium-Term (3-12 Months): This period is critical for confirming the disinflationary trend. If subsequent monthly inflation prints remain consistent with a path to 2%, market pricing for rate cuts in mid-to-late 2026 will become firmly anchored. Corporate and government budget planning for the following fiscal year will begin to incorporate a lower interest rate outlook.

Long-Term (1-3 Years): The actual path of interest rates will be determined by which of the above scenarios unfolds. Under the base case, a gradual normalization of the federal funds rate towards a neutral level (estimated to be around 2.5%-3.0%) would occur over this period, creating a stable environment for long-term investment.

Quantified Ranges

Federal Funds Rate (Year-End 2026): Scenario 1: 4.25%-4.75%. Scenario 2: 5.25%-5.50%. Scenario 3: 3.50%-4.00%.

U.S. 10-Year Treasury Yield (Mid-2026): Scenario 1: 3.75%-4.25%. Scenario 2: 4.50%-5.00%. Scenario 3: 3.25%-3.75%.

Public Infrastructure Financing: A 50-basis-point (0.50%) reduction in long-term municipal bond yields, as might occur under Scenario 1, could save tens of millions of dollars in interest costs over the life of a $1 billion project.

Risks & Mitigations

Risk: A significant geopolitical event disrupts global supply chains or causes an energy price spike, reigniting inflation. Mitigation: For governments, maintaining strategic reserves and pursuing diplomatic de-escalation. For corporations, diversifying supply chains and using financial instruments to hedge commodity price exposure.

Risk: The domestic labor market fails to cool sufficiently, leading to sustained high wage growth that keeps services inflation elevated (as in Scenario 2). Mitigation: The Fed would need to clearly communicate its resolve to keep policy restrictive, managing market expectations. Fiscal policy could focus on non-inflationary, supply-side measures to increase labor force participation.

Risk: The Fed commits a policy error, either easing prematurely and allowing inflation to resurge, or waiting too long to cut rates and causing an unnecessary recession (Scenario 3). Mitigation: Stakeholders in government and industry should not rely on a single economic forecast. They must conduct scenario analysis and stress-test their budgets and financial plans against a range of interest rate paths.

Sector/Region Impacts

Sectors: A path toward lower rates is broadly positive for most sectors. It is particularly beneficial for Real Estate and Construction, where activity is highly sensitive to borrowing costs. Utilities and other capital-intensive sectors benefit from lower financing costs for major projects. Technology and other growth-oriented sectors benefit as lower discount rates increase the present value of future earnings. Banking may face some pressure on net interest margins as rates fall, but this could be offset by improved credit quality and higher loan demand.

Regions: A less restrictive U.S. monetary policy eases global financial conditions. Emerging Markets with significant U.S. dollar-denominated debt receive substantial relief from a stable or weaker dollar and lower U.S. interest rates. Europe and Japan, whose central banks have been more cautious in their own tightening cycles, gain more flexibility to tailor policy to their specific domestic conditions without fearing capital flight to higher-yielding U.S. assets.

Recommendations & Outlook

For Public Finance Ministers & Agency Heads: (Scenario-based assumption) Assuming the base-case "Soft Landing" scenario materializes, begin preparing for a more favorable borrowing environment in the next 12 months. Review and prioritize infrastructure project pipelines; projects previously deemed too expensive may now be viable. Prepare bond issuance strategies to capitalize on declining long-term rates.

For Corporate Boards & CFOs: (Scenario-based assumption) Re-evaluate corporate hurdle rates for capital investments. A lower cost of capital may unlock new growth projects. Proactively review debt structures and consider refinancing higher-cost debt issued during the peak-rate environment. Stress-test financial models against all three scenarios to ensure resilience.

Outlook: This inflation report is a pivotal piece of evidence suggesting the most difficult phase of the inflation fight is over. The narrative is now decisively shifting from if the Fed has done enough to when it can begin to normalize policy. While the path to 2% inflation will not be linear and risks remain, the outlook for public and private capital planning has improved significantly. The primary task for leaders is no longer just navigating high inflation and rising rates, but preparing for a new, more stable, but still uncertain macroeconomic environment. Prudent planning should be based on the high-probability "Soft Landing" scenario while maintaining contingency plans for the less likely but still plausible alternatives.