US May PCE Preview: Fed Officials Are Likely to Observe Positive Progress in Disinflation

The Bureau of Economic Analysis will release the Personal Consumption Expenditure and the price index at 8:30 ET on Friday.

Economists polled by Bloomberg expect core PCE inflation to slow to 0.1% in May, its slowest pace this year, with the year-over-year figure dropping to 2.6%, the lowest since March 2021. Headline PCE inflation will likely fall to 0.0%, and will slow down to 2.6% on a year-over year basis, mainly driven by falling energy and used car prices last month.

Economists are anticipating that the strength of the U.S. dollar will play a significant role in alleviating inflationary pressures. A weak dollar once led to several oil crises in the 1960s, 1970s and 1990s.

The U.S. dollar index has remained strong since April. A strong U.S. dollar can lower import prices and curb the rapid rise in commodity prices, thereby making inflation likely continue to decline in the coming months.

Bloomberg economist Estelle Ou expected that faster hiring and wage growth likely drove personal income gains of 0.5% in May (vs. 0.3% prior). Personal spending is anticipated to rise 0.3% (vs. 0.2% prior) as consumers hunt for bargains online and rein in spending on some discretionary services. The combination of rising income and declining inflation is beneficial for real economic growth, though it also increases the risk of another rise in inflation.

Drewy’s World Container Index increased 7% to $5,117 per 40ft container this week and has increased 233% when compared with the same week last year. Although the port congestion experienced during the pandemic is unlikely to recur, changes in the routes along Middle Eastern shipping lines may increase shipping costs. Since many consumer goods still rely on maritime transportation, continuously rising freight rates may eventually be passed on to the final consumer products.

In its mid-year policy update, the Federal Reserve noted a slight improvement in efforts to tackle inflation, but still revised its end-of-year inflation outlook upwards marginally, from 2.4% to 2.6%. While the downward trend in inflation has been received positively by officials, they have underlined the importance of sustained signs of inflation easing before they can confidently say it will settle around their target level, and then open the door for interest rate reductions.

The Fed's latest economic projections in June have tempered expectations for lowering interest rates, now predicting just one cut in 2024, a more conservative stance compared to the previously forecasted three cuts.

CME FedWatch shows that rates markets imply potential for two Fed cuts in 2024. Currently, the markets are pricing in a better than 50/50 chance of one cut coming at the September meeting. If the PCE data released on Friday falls as expected, it will increase the likelihood of a rate cut in the third quarter.

Source: CME, Bureau of Labor Statistics, Bloomberg