Latest PCE Inflation Data Indicates Persistent Inflation Despite Positive Outlook

Key takeaways

• Headline PCE inflation was at 3.8%, the lowest result since 2021
• However, core inflation only shifted to 4.6% and remains somewhat static
• With unemployment claims dropping, new home sales increasing and GDP growth coming in higher than expected, the Fed clearly has more work to do in tackling inflation

The latest personal consumption expenditures (PCE) price index was yet another mixed bag, with headline inflation looking peachy and core inflation turning sour. Paired with other key economic data sets on jobs, house prices and GDP growth, the economy has proven surprisingly resilient in the face of mammoth interest rate rises.

All of this leaves a lot for the Fed to think about, with the stock market wavering on Monday morning as jobs data later this week could all but confirm a rate increase for July. Here’s the lowdown.

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What’s the latest inflation data?

The PCE price index is the Fed’s preferred gauge of inflation, and on the face of it, the data looked good. Headline PCE inflation rose 3.8% from a year earlier, which is the lowest figure in two years. Given the peak was at 7% a year ago, the rate has nearly halved in a year.

Core PCE inflation, which strips out volatile food and energy prices, rose to 4.6% in May year-on-year, which is down marginally from April’s 4.7% figure. It’s proof that inflation remains sticky, given that the core PCE readings haven’t moved much in seven months.

Household spending rose 0.1% in May, which was slightly lower than the 0.2% growth expected by analysts. However, prices are still rising in bubbles of the economy. Services spending rose by 0.4%, buoyed by the travel industry and healthcare among others. Goods spending came in at 0.5%, down from April’s 0.9% figure, with spending on gas and vehicles plunging by 23% each.

In short, the headline PCE data is good news, but core inflation suggests stickiness. Are the results enough to persuade economists and the Fed that enough work is being done to tackle inflation? Well, that depends on the other data.

What other data do we have?

The PCE index is only one part of the puzzle: CPI, jobs and house prices can tell us more about the U.S. economy’s health.

CPI shows a similar picture to PCE. For May, headline CPI fell to 4%, the lowest result in two years and a sharp decline from April’s 4.9% reading. However, core inflation fell from 5.5% in April to 5.3% in May, indicating persistent price pressures might be keeping inflation up.

New jobs data last week revealed new claims for unemployment benefits fell by the biggest drop in 20 months, with 239,000 claims filed – a 26,000 drop from the week before. Analysts had previously said unemployment claims needed to be at around 280,000 to indicate a significant decline in job growth.

New home sales data also unveiled new U.S. single-family home sales surged to their highest levels in nearly 18 months as a dearth of existing home inventory created pent-up demand. New home sales climbed 12.2% to 763,000 units sold last month, much higher than the 675,000 predicted.

On a macro scale, we also saw the U.S. economy’s GDP growth revised upwards. The first quarter of the year saw the economy reach a 2% annual growth rate, higher than the 1.3% estimate and driven by consumer spending. It was good news for avoiding a recession and hitting the ‘soft landing’ the Fed is after, but again, it suggests consumer spending power is helping keep inflation high.

The market reaction

Wall Street remained positive and made some gains before the bell rang for the long weekend. The Dow Jones Industrial Average was up 0.6% on Friday, while the S&P 500 climbed 1.1%.

We’re expecting more jobs data this week which could scupper the stock market, as the data influences the Fed’s thinking around interest rates. On Monday morning the Dow Jones futures slipped 0.1%, the S&P 500 futures were flat and the Nasdaq futures were up 0.24%.

When could inflation come down?

The Fed’s main (and arguably, only) weapon in its arsenal to fight inflation is to raise interest rates. In theory, this curbs consumer spending, makes borrowing more expensive and puts pressure on businesses, leading to higher unemployment rates.

Last month the Fed paused on rate hikes for the first time in nearly a year to let the economy ‘do its thing’ (our words, not the Fed’s). Interest rates are currently sitting at the 5% to 5.25% benchmark.

At the ECB Forum for Central Banking in Portugal last week, Fed chair Jerome Powell said the last quarter showed “stronger than expected growth, tighter than expected labor markets and higher than expected inflation”. With that in mind, Fed officials are said to be considering two more interest rate rises before the year is out.

If it feels like we’ve been discussing a recession forever, it’s because we have. While inflation remains sticky, raising interest rates to fight it is a double-edged sword. Too much stress on the system can lead to failures, as we saw in March with the regional banks. Too little effort and inflation remains high as wages fill the gap.

The CME FedWatch tool currently puts the chance of a quarter-point rate increase at the July meeting at just over 87%, whereas a hold on rates after that for the September meeting is sitting at 68%. This could all change as more data comes in, but it certainly looks like we’ll be seeing the Fed remain hawkish until the results show otherwise.

The bottom line

As has been the persistent theme of the last few months, inflation data continues to bring us mixed results. While the latest PCE data is trending in the right direction, the Fed will be concerned that core inflation hasn’t moved much while other parts of the economy appear to be gaining momentum again.

All of this suggests that inflation will be a lot harder to tackle going forward. The Fed has a tricky line to tread between balancing the economy’s health and raising interest rates high enough that they have the desired effect – but if core inflation remains sticky across the board, then don’t expect an inflationary retreat any time soon.

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