The Federal Reserve's chief measure of inflation growth fell to its lowest point since March 2021 and within striking distance of the central bank's target. Yet a long-awaited rate cut remains highly unlikely before September, Fed watchers said.
The core personal consumption expenditures (PCE) price index, which excludes volatile food and energy prices, rose 2.6% from May 2023 to May 2024, the US Bureau of Economic Analysis reported June 28.
The increase was within economists' expectations and was the smallest in more than three years. It is a likely respite for Fed officials who have fretted over annual core PCE growth, which has hovered around 2.8% for the previous three months.
The central bank has held its benchmark federal funds rate above 5% for nearly a year and Fed Chairman Jerome Powell has repeatedly said rate cuts are not coming until annual core PCE growth shows meaningful progress toward 2%. While the inflation slowdown signals some progress toward the Fed's goal, it is likely not enough to shift expectations from a view that rate cuts will start in the fall.
"I don't think it changes the calculus for the Fed," said Michael Arone, chief investment strategist for the US SPDR business at State Street Global Advisors. "They'll continue to be data dependent. But I do think it allows investors to breathe a sigh of relief to suggest that April's hotter-than-expected data may have been a bit of a hiccup and we're back on track for data falling, rather than accelerating."
'Road to normalization'
After the latest inflation data was released June 28, the odds of a rate cut at the Fed's next meeting in late July were about 10%, essentially unchanged from a month earlier, according to the CME FedWatch Tool, which measures investor sentiment in the Fed funds futures market.
The odds of at least one cut by the Fed's September meeting were at about 66% on June 28, up from about 46% a month earlier, according to the tool.
The modest decline in core PCE was "another step on the road to normalization," said Oren Klachkin, a financial market economist at Nationwide.
While there are signs of overall cooling, the economy continues to expand, likely keeping the odds of a near-term rate cut very low, Klachkin said.
"The only way we get a July cut is a deterioration in the jobs machine and consumer spending that leads Fed officials to materially alter their views on the economy," Klachkin said.
For the Fed to consider a cut at its meeting in July, there would need to be considerable weakening in the labor market.
The unemployment rate, which had been below 4% since February 2022 before hitting that mark in May, would need to rise "notably," possibly by 20 basis points, Arone with State Street said. "The Fed wants to cut rates, they just want the data to confirm that inflation is in fact falling before they do that."
Before the next Fed meeting in late July, the jobs report for June will be released only July 5. Additionally, the latest consumer price index, the market's preferred inflation measure, will be released July 11, and the PCE for June will come out July 26.
"Investors know there will likely be several steps involved before the Fed feels confident enough to cut rates," said Bret Kenwell, US investment analyst with eToro. "To get a cut in July at this point, we would likely need to see a combination of cooler-than-expected inflation and weaker-than-expected economic and labor reports."
While the Fed is now expected to cut rates in September, monetary policy easing this fall is not a sure thing, James Knightley, chief international economist with ING, wrote in a June 28 note. The Fed needs to see more evidence that inflation pressures are easing, additional signs of labor market slack, particularly with cooling wages, and a softening in consumer spending before it can cut, Knightley wrote.
"The Fed doesn't want to cause a recession if it doesn't have to and if the data allows it to start making monetary policy slightly less restrictive, we think the Fed will take that opportunity," Knightley said.