May PCE Inflation as Expected, Likely Clearing Way for Sept. Fed Rate Cut

The May Personal Consumption Expenditures Price Index increased as was widely expected, up 2.6% from year-ago levels.

When volatile food and energy costs are factored out, the Federal Reserve’s preferred measure of inflation also increased 2.6% from one year ago, as predicted. The index was unchanged from month-ago levels. Excluding food and energy, it increased 0.1%.

“Today’s data came about in line with our expectations, so we still expect the first [interest] rate cut to come this September,” says Morningstar’s chief US economist Preston Caldwell. “The Fed will need to see a few more months of lower inflation data to be okay with cutting. If we have an extremely abrupt weakening in the economic situation over the next month (jobs report, retail sales, etc.), a July cut is possible, but it’s highly unlikely overall.”

May PCE Inflation Report Highlights

• The PCE Price Index held steady in May, in line with the FactSet consensus forecast and following an increase of 0.3% in April.
• Core PCE rose 0.1% in May, in line with forecasts and following an increase of 0.3% in April.
• The PCE Price Index rose 2.6% year over year in May, in line with forecasts and following an increase of 2.7% in April.
• Core PCE rose 2.6% year over year in May, in line with forecasts and following an increase of 2.8% in April.

“Core PCE inflation spiked to 4.5% annualized in the three months ending in March 2024, after averaging merely 1.9% in the last six months of 2023,” Caldwell says. “But the bout of renewed high inflation looks to have been short-lived. Core PCE inflation has fallen to 2.7% in the three months ending in May. The overall trend remains downward, with core PCE inflation sliding to 2.6% on a year-over-year basis, down from 2.9% at the start of 2024.”

Housing Inflation Continues to Lift PCE Inflation

Caldwell notes that the first-quarter rise in core inflation was driven by core goods and services excluding housing. “Both categories have since dropped back,” he says. “It seemed unlikely that higher core goods inflation would persist, given that supply-side conditions remain favorable.”

In addition, the jump in core services inflation excluding housing had been heavily driven by a jump in financial services inflation, which has faded. Core services inflation excluding housing came in at a 3.2% annualized rate for the past three months, down from 5.5% as of March. That easing of upward pressure on prices was fueled by a drop in financial services, along with costs like cellphone and streaming services.

“From a broader perspective, housing inflation, at 5.5% year over year in May, is now almost the sole contributor to inflation’s excess over the Fed’s 2% target,” Caldwell says. “Indeed, core PCE inflation excluding housing was just 1.9% year over year in May. Leading-edge data on market rents still points to a coming drop in measured housing inflation. Also, the gap between core CPI and core PCE is mostly attributable to the former’s larger weight to housing.”

Meanwhile, core goods prices have been flat over the past three months, Caldwell notes, with durables prices down 3.8% on an annualized basis. “Prices were down nearly across the board within durables,” he says. “However, prices for core nondurables did increase by 3.9% annualized, driven by clothing and especially pharmaceuticals.”

In the wake of the PCE report, expectations for a Fed rate cut in September ticked higher, according to the CME FedWatch tool. Traders in the bond futures market now peg the odds of a quarter-point cut in September at roughly 60%.