US May PCE Index Hits 3-Year High, Fed Rate Hike Eyed for September

U.S. inflation accelerated in May, reaching its highest point in three years according to the Federal Reserve's preferred gauge, the Personal Consumption Expenditures (PCE) price index. The Commerce Department reported that the PCE index rose 4.1% year-over-year, exceeding March's 3.8% and marking the highest level since April 2023. While the monthly increase of 0.4% was slightly below market expectations of 0.5%, the underlying trend suggests persistent price pressures.

Excluding volatile energy and food prices, the core PCE index also saw an uptick, climbing to 3.4% year-over-year from 3.3% in April. This increase, matching market forecasts, indicates that broader price pressures continued into May. High energy prices have been a significant driver of overall inflation, but the rise in core inflation suggests that price increases are becoming more widespread.

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We can expect that the June inflation data will show a negative month-over-month increase.

Federal Reserve officials have signaled a pause in interest rate hikes for the remainder of the year, with some anticipating a single increase. However, the latest PCE data could complicate their decisions. While Fed Chair Jerome Powell has reiterated the goal of returning inflation to 2%, the persistent rise in prices may lead policymakers to reconsider their stance. Market participants are now looking closely at future economic indicators to gauge the likelihood of a rate hike as early as September, which could put pressure on technology stocks, as seen in a slight dip in the Nasdaq index following the data release.

Economists offer mixed views on the inflation outlook. Some suggest that inflation may have peaked in May, citing a significant drop in West Texas Intermediate crude oil futures. They anticipate that June's inflation data could show a negative month-over-month increase. However, others caution that core inflation may prove stubborn due to factors like persistent service sector inflation, rising prices from tariffs, demand for AI infrastructure, and anticipated increases related to defense spending. The Fed's own economic projections indicate that overall PCE is expected to reach 3.6% by year-end, with core PCE at 3.3%, before a more significant decline next year.

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I do not think core inflation will cool down easily, as service sector inflation is stubborn, tariffs are causing rising commodity inflation, price pressure due to AI infrastructure construction, and upcoming price pressure related to defense spending.