Federal Reserve Chairman Jerome Powell gave two clear reasons why the central bank raised interest rates by 0.75 percentage point at its June meeting and left the door open to do it again in July. Two weeks later, both factors could be fading already.
One was consumers’ inflation expectations, which had jumped in a preliminary report just before the Fed’s policy meeting but have since, in a final reading, fallen back roughly in line to where they have stood for the past year.
The other was inflation, which had surprised to the upside and jumped more than expected in May, as measured by the consumer price index. But the Fed itself prefers a different gauge, the personal consumption expenditures price index—and that measure showed on Thursday that inflation might be starting to cool off, at least when backing out volatile food and energy prices.
The so-called core PCE climbed 0.3% in May, coming in below consensus expectations of 0.4% and matching the inflation rate of each of the previous three months. On an annual basis, the core PCE index climbed 4.7% in May over a year ago, down from 4.9% the previous month.
That offers some reason to believe a second three-quarter-point rate increase next month could be less likely than originally thought. As of Monday, traders were pricing in a 96% chance of a 0.75-percentage-point outcome, according to CME data. That fell to 81% by Thursday after the PCE data was released.
To be sure, the pace of price increases continues to come in far hotter than the Fed’s 2% target. But the month-over-month deceleration in core PCE inflation could mean that price gains are reaching a peak.
“The 0.6% May print is still too high, and June’s likely will be similar,” wrote Ian Shepherdson, chief economist with Pantheon Macroeconomics. “But we expect much smaller increases from July onwards. If the Fed recognizes that, then a 75bps July hike can still be averted, but it’s a close call.”
Further underscoring the need for the Fed to tread carefully moving forward: Inflation is finally weighing on consumer spending, which fell over the month once higher prices are taken into account as Americans pulled back on big-ticket purchases, the report shows. Consumers are now feeling squeezed from both sides, with interest rates rising while prices remain elevated.
“The Fed realizes it’s going to have to walk a very difficult line,” says Cailin Birch, global economist at the Economist Intelligence Unit. “Another 75 basis point hike would certainly move faster to tamp down on demand and tamp down on inflation, but it might be so fast that it risks collapsing household spending.”
There’s plenty of data to be released before Fed officials sit for their next policy meeting in late July, including a jobs report and fresh round of CPI data. But there are indications so far that the Fed’s 0.75-percentage-point move may have been more of an outlier than the start of a new trend.
Write to Megan Cassella at firstname.lastname@example.org