US Q2 GDP rebounds; PCE inflation edges higher to 2.7%

29 Sep 2025 , 12:29 PM

BACKGROUND TO THE FED RATE DEBATE

The US Fed rate decisions are based on the dual mandates of maintaining price stability and creating maximum employment. Generally, rate cuts are seen as inevitable when it is essential to boost growth and jobs. On the other hand, rate hikes become essential when the inflation has to be controlled and is rampant on the upside. Today, we have a conflict on the rate decision front; due to diverse macro indicators.

In the last few weeks, Jerome Powell has been pushing for a cautious approach to rate cuts as inflation had gone higher and tariffs looked poised to spike inflation further. On the other hand, Michelle Bowman is of the view that the tariffs are likely to hit GDP and jobs much harder and it is essential to pre-empt a jobs crisis. Bowman favoured a more aggressive approach to rate cuts to boost growth and jobs.

FIRST CONTEXT – Q2 GDP FINAL ESTIMATE ANNOUNCEMENT

The US Bureau of Economic Analysis (BEA) puts out 3 estimates of GDP growth for each quarter. The US economy contracted in the first quarter of 2025 due to front-loading of imports. However, GDP growth bounced back sharply in the second quarter. The first estimate of Q2GDP came in at 3.0%, which was upgraded to 3.3% in the second estimate, and further to 3.8% in the final estimate.

What is more important is that this GDP rebound has been supported by a bounce in consumer spending. Hence, any immediate growth concerns look unlikely for the US economy. With the unemployment steady at around 4.3%, the only concern is the low level of non-farm payroll additions on a monthly basis. The Q2 GDP does not hint at any urgent need to cut the repo rates aggressively to boost growth.

SECOND CONTEXT – AUGUST PCE INFLATION READING

A day after the GDP data announcement, the PCE inflation based on personal consumption expenditure was also put out. PCE inflation edged up by 10 bps to 2.7%, and has now moved up by 40 bps since April 2025. This spike in PCE inflation appears to be a clear outcome of the steep tariffs imposed. Even as headline PCE inflation has stayed nearly 70 bps above the long-term target rate of the Fed, the core PCE inflation has hovered around the 3% mark. It is normally, the PCE inflation, which is used as a metrics by the Federal Reserve for taking a call on rate direction. With PCE inflation elevated at 2.7%, even this data point is not indicative of the need for aggressive rate cuts at this point of time.

MARKETS HAVE OTHER IDEAS ON RATE CUTS

A good way to gauge market sentiments on rate cuts is to look at the CME Fedwatch, which captures probabilities of rate cuts over the next few Fed policy statements. It is derived from the Fed Futures trading prices.

Fed Meet	200-225	225-250	250-275	275-300	300-325	325-350	350-375	375-400	400-425	425-450
Oct-25	Nil	Nil	Nil	Nil	Nil	Nil	Nil	89.8%	10.2%	Nil
Dec-25	Nil	Nil	Nil	Nil	Nil	Nil	65.3%	32.0%	2.8%	Nil
Jun-26	Nil	Nil	0.5%	5.5%	20.8%	36.2%	28.2%	8.1%	Nil	Nil
Dec-26	0.7%	3.2%	10.7%	22.4%	29.0%	22.5%	9.6%	1.9%	0.1%	Nil

Data source: CME Fedwatch

After the 25-bps rate cut by the Fed in September, here are some key expectations.

• CME Fedwatch is betting on an additional 25-50 bps rate cut in 2025, with 25-bps rate cut looking certain, and another 50-bps looking less likely.
• By December 2026, there is a high probability of 88.4% that rates will be in the range of 3.25% to 3.50%. That would be a cut of 200 bps from peak 2024 rates.

For now, CME Fedwatch is being optimistic about rate cuts. However, a lot will depend on how the FOMC deliberates on the macros and arrives at its inferences.