In May, U.S. monthly inflation held steady as a slight uptick in service costs countered the largest drop in goods prices in six months, a Commerce Department report revealed on Friday. This development nudged the Federal Reserve closer to contemplating interest rate cuts later in the year.
Consumer spending saw marginal growth during the same period, according to the report, marking a slow increase in underlying prices over the last six months. Economists view this as a positive sign, suggesting the Fed might achieve a desired “soft landing” for the economy, cooling inflation without causing a recession or sharp unemployment rise.
Traders responded by increasing their bets for a Fed rate cut in September. Scott Anderson, chief U.S. economist at BMO Capital Markets, commented, “This was a very Fed-friendly report that should keep the September rate cut in play.”
The Personal Consumption Expenditures (PCE) price index showed no change last month, following a 0.3% increase in April. This stability marks the first time in six months that PCE inflation remained unchanged. Notably, goods prices fell by 0.4%, the largest decline since November, driven by decreases in recreational goods, vehicles, furnishings, and durable household equipment.
Energy-related goods, including gasoline, saw a significant 3.4% decrease, while clothing and footwear prices also dropped. In contrast, service costs rose by 0.2%, lifted by higher prices in housing, utilities, and healthcare. However, financial services and insurance costs declined by 0.3% after five consecutive months of increase.
Over the past year through May, the PCE price index rose by 2.6%, slightly lower than the 2.7% increase recorded in April and in line with economists’ expectations. Despite recent rate hikes by the Fed, inflation remains above the central bank’s target of 2%.
Financial markets reacted to the data by increasing the likelihood of a Fed policy easing starting in September, with a 68% probability compared to 64% before the report. The Fed has maintained its benchmark interest rate range of 5.25%-5.50% since July last year.
Economists are divided on whether the Fed will proceed with two interest rate cuts this year, given solid wage growth. More clarity is expected with the upcoming U.S. employment report for June, which could influence the Fed’s monetary policy decisions.
On Wall Street, stocks traded mostly higher, while U.S. Treasury prices showed mixed results. The dollar remained stable against a basket of currencies.
Consumer spending, a significant driver of U.S. economic activity, rose by 0.2% in May, following a 0.1% increase in April. This growth was supported by a 0.3% increase in services spending, particularly in hospital care, housing, utilities, and air transportation. Spending on goods also rebounded by 0.2%, driven by outlays on prescription medication, recreational goods, vehicles, and clothing.
Despite concerns such as inflation fatigue and higher borrowing costs, consumer spending remains supported by a strong labor market, which continues to see robust wage gains. Personal income increased by 0.5% in May, with wages rising by 0.7%.
Adjusted for inflation and taxes, household disposable income rose by 0.5%, contributing to an increase in the saving rate to 3.9% from 3.7% in April. Real consumer spending, adjusted for inflation, rebounded by 0.3% after a slight decline in April.
Looking ahead, the Atlanta Fed forecasts that the gross domestic product (GDP) will grow at a 2.2% rate in the second quarter, up from 1.4% in the first quarter.
Chris Low, chief economist at FHN Financial, noted, “There was no inflation in May, but there was also no indication of the kind of soft demand – undermined by slower income growth – the Fed believes necessary to keep inflation on a low track.”
Overall, the latest economic indicators suggest a complex landscape for the Federal Reserve, balancing between managing inflation and supporting economic growth amidst global uncertainties.
