Slowing U.S. Inflation Fuels Expectations of Interest Rate Cuts

The U.S. Federal Reserve’s preferred inflation gauge met forecasts in May, keeping alive expectations that interest rates could fall faster than policy makers forecast.

The core Personal Consumption Expenditures Price Index, which excludes volatile energy and food prices, increased 2.6% from a year ago, slowing from April’s 2.8% pace. The reading met the consensus of economists surveyed by The Wall Street Journal.

Core PCE inflation rose 0.1% in the month, compared to a 0.2% increase in April. The headline 12-month reading was 2.6%, slowing from April’s 2.7% pace. In the month, the PCE was flat after rising 0.3% in April, marking the first time consumer prices didn’t go up in six months.

Consensus was met in all readings.

The Fed targets 2% inflation.

“The overall trend we’ve been seeing of disinflation in general isn’t always going to be a smooth ride,” said Kevin Flanagan, head of fixed income strategy at WisdomTree. He expects inflation to keep ticking lower in coming months. “It may be a little more difficult finding out that last mile to get to the Fed 2% goal.”

Treasury yields fell following the data release. Markets have been mostly pricing in an initial 25-basis point interest rate cut in September, plus a second trim still in 2024, according to CME data. Fed officials project only one cut this year. They have said repeatedly that inflation data will determine their next step, and some even left the door open to an interest rate increase.

Forecasts of a more aggressive easing cycle rely mostly on estimates that inflation could collapse as the economy is weighed down by high borrowing costs.

June PCE inflation is due July 26, just ahead of the next rate-setting Fed meeting on July 30- 31.

Inflation is unlikely to accelerate as it did earlier this year, said Scott DiMaggio, director of global fixed income at AllianceBernstein . He warned that year-over-year readings are likely to decline more slowly when compared to the weakening gauges of late 2023.

“We still have some sticky components specially on the services side and that is going to take time to move down,” he said. “We don’t see us getting back to the Fed target until 2025.”

Early end-of-financial-year promotions and mid-year sales events attracted consumers to the shops in May, with Australian retail turnover rising 0.6 percent, according to seasonally adjusted figures from the Australian Bureau of Statistics (ABS). This compares to a 0.1 percent rise in April and a 0.4 percent fall in March.

Robert Ewing, ABS head of business statistics, said consumers were “watchful” and motivated by discounts amid today’s high cost of living.

“Many retailers started end-of-financial–year sales early, offering larger discounts than usual and noted that shoppers remain price-sensitive in response to persistent cost-of-living pressures,” Mr Ewing said. “Retail businesses continue to rely on discounting and sales events to stimulate discretionary spending, following restrained spending in recent months.”

However, May’s boost belies “stagnant” underlying demand trends. Mr Ewing notes retail trading in trend terms is up by 1.5 percent over the year to May, which is very low. Gareth Aird, Head of Australian Economics at CBA, points out that population growth in 2023 was 2.5 percent, so on a per-capita basis a 1.5 percent lift in spending is exceptionally weak.

Mr Aird said shoppers are “savvy, cautious and price sensitive” and “more tactical than usual when determining when to spend on discretionary items”. Non-food retail was stronger than food retail in May, with the highest rise being a 1.6 percent lift in clothing, footwear, and personal accessories spending. Household goods spending lifted 1.1 percent.

Deloitte Access Economics partner, David Rumbens, says frugality is “back in vogue” with persistently rising prices for essentials like rent, insurance and utilities forcing consumers to cut back on discretionary purchases. An expected reduction in population growth as immigration reduces over the next year may also keep retail spending weak.

Deloitte’s latest retail forecasts point to a rocky road ahead, particularly if unemployment rises. Mr Rumbens said the 3.75 percent lift in minimum and award wages give consumers more spending power but will put pressure on business costs. He points out retail and hospitality insolvencies are increasing in today’s economy.

However, tax cuts and eventual interest rate cuts should lead to more retail spending in the second half of 2024 and in 2025. Deloitte forecasts no growth for retail spending overall in 2024 but a 2.5 percent uplift in 2025. “Household goods turnover should pick up more with better economic conditions and with an uplift in national building activity, supported by the Government’s ambitious housing targets,” Mr Rumbens said.

Slowing U.S. Inflation Fuels Expectations of Interest Rate Cuts

Inflation unlikely to accelerate as it did earlier this year, said AllianceBernstein’s Scott DiMaggio

Discounts prove irresistible to shoppers motivated by cost of living pressures