US inflation data offers no quick relief for the Fed, but hints at a peak

WASHINGTON (Reuters) – Fresh U.S. data for May showed immediate slight relief from the record pace of inflation that pushed the Federal Reserve towards another big interest rate hike next month, but added to a growing sense that the worst may be over. .

PCE inflation was 6.3% year-on-year in May, the same as in April and still more than triple the US central bank’s official target of 2% – far from clear evidence of lower inflation that Fed officials say they Need before backtracking on their plans to raise interest rates. Read more

After the release of the latest inflation data, futures traders tied to the central bank’s target federal funds rate kept their bets on going ahead with a 75 basis point rate hike next month.

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But those same traders also saw an opening for the Fed to slow the pace of price increases from November and stop raising rates altogether in early 2023, as evidence mounts that inflation may have peaked and the economy is slowing overall.

While the headline inflation figure showed no decline, a separate measure that excludes volatile food and energy prices fell for the third month in a row and is now at a six-month low of 4.7%.

The measure of so-called “core” inflation is controversial, because it excludes some of the prices that most affect daily life. The Fed’s focus on PCE inflation, as opposed to a separate CPI, which is usually higher, is also a topic of debate because it gives less weight to the costs of items like housing that have also been rising rapidly.

But the decline in core PCE, if it continues, will continue to carry weight among policy makers as a strong indication of where prices are headed.

“The combination of sluggish wage gains, lower margin inflation, and a stronger dollar is starting to make a clear slowdown in core inflation ‘to go’ to become convincing for the Fed,” Ian Shepherdson, chief economist at Pantheon Macro Economics, wrote in a note.

But the seeds of that may be rooted.

Recent revisions to the data showed that consumer spending at the start of the year was lower than originally expected, and data released Thursday showed that on an inflation basis, both disposable income and consumer spending fell in May.

Booming consumer demand, fueled in part by trillions of dollars in pandemic relief payments from the federal government, is one factor behind the recent price hike. The Fed’s goal in raising interest rates was to bring this record demand for goods and services more in line with what the economy could produce or import.

Michael Pierce, chief US economist at Capital Economics, estimated that US economic growth in the April-June period slowed to an annual rate of 1%. That’s well below US trend growth rates typically estimated at around 2%, a kind of “production gap” that could ease demand-related pressure on prices.

“We expect growth to remain below trend during the second half of the year as well,” Pierce wrote.

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Between those signs of slowing growth and the possibility of slowing inflation, it is now a matter of Federal Reserve judgment on how to balance the need to pursue expected price increases against the risks that the economy may slow faster than expected or even slide into recession.

At a central banking conference in Portugal this week, Fed Chairman Jerome Powell made clear – once again – that the impediment to the US central bank from slowing or halting further interest rate increases is high. Policymakers want to make sure that public views of long-term inflation do not drift upward, a fate they feel they have avoided thus far, but which they also tend to reinforce beyond any reasonable doubt. Read more

They have also watched financial markets take the expected monetary tightening seriously, and raise the cost of credit much faster than the Fed itself has acted on raising the short-term Fed funds rate. For example, the average contract rate on a 30-year fixed rate mortgage in the US has nearly doubled to 5.70% since last September when the Fed signaled its pivot to tighten credit conditions. The first increase in the Fed’s current tightening cycle didn’t come until March.

For the Fed, this is like money in the bank, and it won’t be handed over easily.

“Pretty much since last fall when we were pivotal … the markets have been well aligned … with where we’re headed,” Powell said on Wednesday. “It’s constructive for the market to actually do the work for you.”

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(Covering) Howard Schneider Editing by Paul Simao

Our Standards: Thomson Reuters Trust Principles.

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