Last week ended with a test. The August core PCE would show whether the underlying inflation trend, stuck at 3.3 percent for four months, was finally moving. Kevin Warsh had put the level at roughly 3.2 percent, and markets priced around 70 percent odds of a rate increase on 28 October. On Wednesday the number arrived: 3.0 percent. Better than the Fed chair himself had suggested, and well below the 3.3 percent economists expected.
Short-term markets reacted swiftly. By Thursday the odds of an October hike had fallen to roughly a quarter, and two Fed officials said there was no hurry.
Long-term yields did not join in. On Thursday the ten-year touched 5.34 percent, its highest since 2002. The inflation figure fell largely because the way it is measured changed. The Fed took a step back. Long-dated government bonds took no notice of either.
Inflation fell mostly on paper
The headline story was simple: core PCE at 3.0 percent, headline PCE at 3.4 percent against an expected 3.7, and a monthly core increase of 0.2 percent. The details tell a different one. Alongside the August data, the Bureau of Economic Analysis published its annual update and changed how several prices are measured, including portfolio management fees, legal services and computer software. Those changes alone pulled core inflation down by around a third of a percentage point. July, which this series recorded at 3.3 percent, now also stands at 3.0 percent.
August therefore brought no sudden cooling. The trend has not broken. The yardstick has been shortened.
The same revision raised second-quarter growth to 2.2 percent from 1.5. Real consumer spending rose 0.6 percent in August, the strongest monthly gain since March 2025, while real disposable income slipped and the saving rate fell to 4.1 percent, the lowest since late 2022. On Thursday the prices index of the ISM manufacturing survey jumped to 77.9 from 71.1. A lower inflation rate on paper sits beside an economy that is still running hot.
The Fed takes its time
Fed officials had prepared the ground. On Tuesday New York Fed president John Williams said that after the September increase "there is no need for urgency," although one more increase this year still looked reasonable to him. On Thursday Vice Chair Philip Jefferson said the committee's judgment "may take more time." Minneapolis Fed president Neel Kashkari added that inflation around 3 percent remains too high.
The market heard the first two more clearly than the third. The probability of a hike on 28 October fell from around 72 percent on Tuesday to roughly 25 to 30 percent by Thursday, depending on the measure. Goldman Sachs moved its expected next increase to December.
Last week the market ran ahead of the committee. This week it fell behind it. Twelve of eighteen participants pencilled in one more increase, and nothing said this week withdrew that. The Fed has not changed its view. It has changed its timetable.
Long-term rates do not listen
The yield curve tells the week in two numbers. The two-year fell from 4.92 percent on Monday to 4.78 percent on Thursday, in line with a Fed in less of a hurry. The thirty-year rose from 5.49 percent last Friday to 5.64 percent on Wednesday, and the ten-year from 5.17 to 5.29 percent, before touching 5.34 percent intraday on Thursday and settling at 5.24. The ten-year closed the third quarter with its largest quarterly rise in more than three decades.
A steepening curve carries a message. Investors worry less about the next Fed decision and more about what it costs to lend to the American government for a long time, with energy-driven inflation and heavy borrowing needs. The Treasury offered little to lean on: this week's only buyback was a purchase of 605 million dollars in inflation-protected securities. The size of future buybacks follows on 4 November.
Equities absorbed the pressure unevenly. The S&P 500 closed September with a monthly loss, fell 0.8 percent on Monday to 7,684 and ended Thursday around 7,672, below the 7,707 of a week earlier. The Dow lost 443 points on Wednesday. The Nasdaq held up thanks to chipmakers after strong results from Micron, while smaller companies kept falling. A softer inflation number should have lifted the whole market. It lifted only the part that does not need cheap money.
Europe gets the inflation the United States lost
In Europe inflation moved the other way. German inflation rose to 3.3 percent in September, with energy up 14.9 percent on the year, and Spain reached 5 percent, its highest since 2023. France and Italy also surprised to the upside. The euro area flash estimate, due on Friday, is expected around 3.6 percent, up from 3.2.
Christine Lagarde chose her words carefully. Before the European Parliament on Monday she said the energy shock is too large to look through, but that she sees "no signs yet" of it becoming embedded in wages. Many economists expect the ECB to skip 29 October and act again in December.
The bond market is not waiting. The French ten-year rose to 4.75 percent on Wednesday against 3.58 percent for the Bund, widening the spread to 117 basis points from 108 last week, the widest since 2012. A vote on a 54 billion euro savings budget follows on 17 November. The euro fell to around 1.12 dollars, its lowest since May 2025. Dutch TTF gas trades around 72 to 74 euros per megawatt hour, more than double its pre-war level, with European storage near 70 percent. Europe enters winter with higher inflation, a weaker currency and a bond market that is already choosing between its members.
Oil holds above 100, gold bends
On Monday President Trump rejected an Iranian proposal to reopen the Strait of Hormuz within seven days in exchange for sanctions relief and an end to the naval blockade, and Brent rose 4 percent to 108.50 dollars. On Wednesday Secretary of State Marco Rubio ordered the Iranian delegation to the UN to leave New York early. The phased deal of last week is, for now, off the table.
Supply news softened the blow. Saudi Arabia resumed loading at Yanbu via its East-West pipeline. The November Brent contract expired on Wednesday at 103.50 dollars, up around 14 percent in September. On Thursday the December contract rose 3 percent to 101.06 after Chinese refiners suspended fuel exports. WTI settled near 92 dollars. OPEC+ meets on Sunday.
Gold fell more than 3 percent on Monday and ended the week around 4,170 dollars, as the dollar index rose to around 101.85, its highest since April 2025. In Japan the yen weakened to around 158 per dollar, with one sudden dip on Thursday that looked more like intervention than trading, while the Nikkei gained around 3 percent on the week on chip stocks. A metal that pays nothing remains hard to hold against a dollar and a yield that both keep climbing.
Where this leaves the markets
On Friday at 14:30 Dutch time the September employment report arrives. Economists expect around 90,000 new jobs, unemployment at 4.1 percent and wage growth of 3.2 percent. Jobless claims fell to 197,000, so a strong reading is not unlikely. With October odds now low, a hot wage figure has more room to surprise than a weak one.
Beyond that the calendar is familiar. The euro area inflation flash lands the same morning, the Fed decides on 28 October, the ECB a day later, and on 4 November the Treasury sets out its buybacks. Behind all of it sits Hormuz, where a phased deal has made way for expelled diplomats.
Last week the bond market spoke louder than the Fed. This week the Fed lowered its own voice. Long-term yields did not follow. The inflation figure changed its yardstick. The bond market did not.
